The Target Rate and Term Structure of Interest Rates
This paper presents a tractable bond valuation model, which further develops the approach proposed by Piazzesi (2005). The short term inter-bank interest rate is equal to the target rate set by the central bank plus a spread. Bond yields are driven by the intensities that determine the probabilities that the central bank may raise or cut the target interest rate. Unlike in Piazzesi (2005), negative intensities have a convenient interpretation and do not complicate estimation, and two accurate approximations to the bond pricing equation provide new closed form solutions for discount bond prices that require no numerical integration. Unlike in Piazzesi the target interest rate can be constrained to be non-negative. Yields, especially long term ones, decrease when the central bank is expected to decide more frequent and/or larger average future changes in the target interest rate. The model lends itself to easy calibration and estimation.
|Date of creation:||Aug 2006|
|Date of revision:|
|Contact details of provider:|| Postal: Department of Economics and Related Studies, University of York, York, YO10 5DD, United Kingdom|
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- Monika Piazzesi, 2005. "Bond Yields and the Federal Reserve," Journal of Political Economy, University of Chicago Press, vol. 113(2), pages 311-344, April.
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"A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables,"
Journal of Monetary Economics,
Elsevier, vol. 50(4), pages 745-787, May.
- 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.
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- Christian Gourieroux & Alain Monfort & Vassilis Polimenis, 2002. "Affine Term Structure Models," Working Papers 2002-49, Centre de Recherche en Economie et Statistique.
- Qiang Dai & Kenneth Singleton, 2003. "Term Structure Dynamics in Theory and Reality," Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 631-678, July.
- Michael Johannes, 2004. "The Statistical and Economic Role of Jumps in Continuous-Time Interest Rate Models," Journal of Finance, American Finance Association, vol. 59(1), pages 227-260, 02.
- Qiang Dai & Kenneth J. Singleton, 2000. "Specification Analysis of Affine Term Structure Models," Journal of Finance, American Finance Association, vol. 55(5), pages 1943-1978, October.
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