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An Extended Macro-Finance Model with Financial Factors

Listed author(s):
  • Dewachter, Hans
  • Iania, Leonardo

This paper extends the benchmark Macro-Finance model by introducing, next to the standard macroeconomic factors, additional liquidity-related and return forecasting factors. Liquidity factors are obtained from a decomposition of the TED spread while the return forecasting (risk premium) factor is extracted by imposing a single factor structure on the one-period expected excess holding returns. The model is estimated on US data using MCMC techniques. Two findings stand out. First, the model outperforms significantly most structural and non-structural Macro-Finance yield curve models in terms of cross-sectional fit of the yield curve. Second, we find that financial shocks, either in the form of liquidity or risk premium shocks have a statistically and economically significant impact on the yield curve. The impact of financial shocks extends throughout the yield curve and is most pronounced at the high- and intermediate frequencies.

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File URL: https://mpra.ub.uni-muenchen.de/17634/1/MPRA_paper_17634.pdf
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File URL: https://mpra.ub.uni-muenchen.de/18816/1/MPRA_paper_18816.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 17634.

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Date of creation: 02 Oct 2009
Handle: RePEc:pra:mprapa:17634
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