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An Extended Macro-Finance Model with Financial Factors

  • 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 excess holding returns. The model is estimated on US data using MCMC techniques. Two findings stand out. First, the model outperforms Macro-Finance benchmark models in fitting the yield curve. Second, financial shocks, either in the form of liquidity or risk premium shocks, have a statistically and economically significant impact on the yield curve.

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File URL: https://mpra.ub.uni-muenchen.de/19554/1/MPRA_paper_19554.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 18840.

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Date of creation: 02 Oct 2009
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Handle: RePEc:pra:mprapa:18840
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