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A Model of Target Changes and the Term Structure of Interest Rates

  • Pierluigi Balduzzi
  • Giuseppe Bertola
  • Silverio Foresi

We explore the effects of official targeting policy on the term-structure of nominal interest rates, adapting relevant insights from theoretical work on "peso problems" to account for realistic infrequency of target changes. Our analysis of daily U.S. interest rates and newly available historical targets provides an interpretation for persistent spreads between short-term money-market rates and overnight fed-funds targets, and for the poor performance of expectations-hypothesis tests: it is the policy-induced component of fed funds dynamics that appears to be erroneously anticipated by the market. Still, allowance for serial correlation in target changes makes it possible to extract from interest-rate data an expected-knoll series which is quite consistent with the assumptions of the model, indicating that some features of the interest-rate-targeting process are incorporated by market expectations.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4347.

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Date of creation: Apr 1993
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Publication status: published as Balduzzi, Pierluigi, Giuseppe Bertola and Silvero Foresi. "A Model Of Target Changes And The Term Structure Of Interest Rates," Journal of Monetary Economics, 1997, v39(2,Jul), 223-249.
Handle: RePEc:nbr:nberwo:4347
Note: ME AP
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  1. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
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  3. Balduzzi, Pierluigi & Bertola, Giuseppe & Foresi, Silverio, 1997. "A model of target changes and the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 223-249, July.
  4. John Y. Campbell, 1995. "Some Lessons from the Yield Curve," NBER Working Papers 5031, National Bureau of Economic Research, Inc.
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  9. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
  10. Andrew K. Rose & Lars E.O. Svensson, 1991. "Expected and Predicted Realignments: The FF/DM Exchange Rate During the EMS," NBER Working Papers 3685, National Bureau of Economic Research, Inc.
  11. Campbell, John & Shiller, Robert, 1987. "Cointegration and Tests of Present Value Models," Scholarly Articles 3122490, Harvard University Department of Economics.
  12. Narasimhan Jegadeesh & George G. Pennacchi, 1996. "The behavior of interest rates implied by the term structure of Eurodollar future," Proceedings, Federal Reserve Bank of Cleveland, issue Aug, pages 426-451.
  13. Timothy Cook & Thomas Hahn, 1990. "Interest rate expectations and the slope of the money market yield curve," Economic Review, Federal Reserve Bank of Richmond, issue Sep, pages 3-26.
  14. Rose, Andrew K & Svensson, Lars E O, 1995. " Expected and Predicted Realignments: The FF/DM Exchange Rate during the EMS, 1979-93," Scandinavian Journal of Economics, Wiley Blackwell, vol. 97(2), pages 173-200, June.
  15. Hans Lindberg & Lars E.O. Svensson & Paul Soderlind, 1991. "Devaluation Expectations: The Swedish Krona 1982-1991," NBER Working Papers 3918, National Bureau of Economic Research, Inc.
  16. Ben S. Bernanke, 1990. "On the predictive power of interest rates and interest rate spreads," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 51-68.
  17. Campbell, John Y & Shiller, Robert J, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 495-514, May.
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  19. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January.
  20. Bertola, G. & Svensson, L.E., 1990. "Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models," Papers 481, Stockholm - International Economic Studies.
  21. John Y. Campbell, 1986. "Money Announcements, the Demand for Bank Reserves and the Behavior of the Federal Funds Rate Within the Statement Week," NBER Working Papers 1806, National Bureau of Economic Research, Inc.
  22. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
  23. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(1), pages 173-224.
  24. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
  25. Hetzel, Robert L, 1981. "The Federal Reserve System and Control of the Money Supply in the 1970s," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 13(1), pages 31-43, February.
  26. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 245-274, April.
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  28. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
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