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No-Arbitrage Taylor Rules

  • Andrew Ang
  • Sen Dong

We estimate Taylor (1993) rules and identify monetary policy shocks using no-arbitrage pricing techniques. Long-term interest rates are risk-adjusted expected values of future short rates and thus provide strong over-identifying restrictions about the policy rule used by the Federal Reserve. The no-arbitrage framework also accommodates backward-looking and forward-looking Taylor rules. We find that inflation and output gap account for over half of the variation of time-varying excess bond returns and most of the movements in the term spread. Taylor rules estimated with no-arbitrage restrictions differ from Taylor rules estimated by OLS, and the resulting monetary policy shocks are somewhat less volatile than their OLS counterparts.

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Paper provided by Society for Economic Dynamics in its series 2005 Meeting Papers with number 22.

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Date of creation: 2005
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Handle: RePEc:red:sed005:22
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