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Affine Macroeconomic Models of the Term Structure of Interest Rates: The US Treasury Market 1961-99

  • Peter Spencer

This paper develops a macroeconomic model of the yield curve and uses this to explain the behaviour of the US Treasury market. Unlike previous macro-finance models which assume a homoscedastic error process, I develop a general affine model which allows volatility to be conditioned by interest rates and other macroeconomic variables. Despite the extensive use of stochastic volatility models in mainstream finance papers and the overwhelming evidence of heteroscedasticity in macroeconomic and asset price data this is the first macro-finance model of the bond market with this feature. My preferred empirical specification uses a single conditioning factor and is thus the macro-finance analogue of the EA1 (N) specification of the mainstream finance literature. This model performs well in encompassing tests that lead to a decisive rejection of the standard EA0(N) macro-finance specification. The resulting specification provides a flexible 10-factor explanation of the behaviour of the US yield curve, keying it in to the behaviour of the macroeconomy.

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Paper provided by Department of Economics, University of York in its series Discussion Papers with number 04/16.

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Date of creation: Jun 2004
Date of revision: Jan 2006
Handle: RePEc:yor:yorken:04/16
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  1. Dewachter, H.D.R. & Lyrio, M., 2003. "Macro factors and the Term Structure of Interest Rates," ERIM Report Series Research in Management ERS-2003-037-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
  2. Peter N Smith & Michael R Wickens, . "Asset Pricing with Observable Stochastic Discount Factors," Discussion Papers 02/03, Department of Economics, University of York.
  3. Svensson, Lars E O, 1998. "Inflation Targeting as a Monetary Policy Rule," CEPR Discussion Papers 1998, C.E.P.R. Discussion Papers.
  4. Frank F. Gong & Eli M. Remolona, 1996. "Two factors along the yield curve," Research Paper 9613, Federal Reserve Bank of New York.
  5. Glenn Rudebusch & Tao Wu, 2004. "A macro-finance model of the term structure, monetary policy, and the economy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  6. Andrew Ang & Monika Piazzesi & Min Wei, 2004. "What Does the Yield Curve Tell us about GDP Growth?," NBER Working Papers 10672, National Bureau of Economic Research, Inc.
  7. Laurence Ball, 1990. "Why Does High Inflation Raise Inflation Uncertainty?," NBER Working Papers 3224, National Bureau of Economic Research, Inc.
  8. Federico M. Bandi & Peter C. B. Phillips, 2003. "Fully Nonparametric Estimation of Scalar Diffusion Models," Econometrica, Econometric Society, vol. 71(1), pages 241-283, January.
  9. Conley, Timothy G, et al, 1997. "Short-Term Interest Rates as Subordinated Diffusions," Review of Financial Studies, Society for Financial Studies, vol. 10(3), pages 525-77.
  10. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
  11. Jiang, George J. & Knight, John L., 1997. "A Nonparametric Approach to the Estimation of Diffusion Processes, With an Application to a Short-Term Interest Rate Model," Econometric Theory, Cambridge University Press, vol. 13(05), pages 615-645, October.
  12. Andrew Ang & Monika Piazzesi, 2001. "A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables," NBER Working Papers 8363, National Bureau of Economic Research, Inc.
  13. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
  14. Yacine Ait-Sahalia, 1995. "Testing Continuous-Time Models of the Spot Interest Rate," NBER Working Papers 5346, National Bureau of Economic Research, Inc.
  15. Glenn D. Rudebusch, 2002. "Assessing Nominal Income Rules for Monetary Policy with Model and Data Uncertainty," Economic Journal, Royal Economic Society, vol. 112(479), pages 402-432, April.
  16. 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.
  17. Chan, K C, et al, 1992. " An Empirical Comparison of Alternative Models of the Short-Term Interest Rate," Journal of Finance, American Finance Association, vol. 47(3), pages 1209-27, July.
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