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Stochastic Volatility in a Macro-Finance Model of the US Term Structure of Interest Rates 1961-2004

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  • Peter Spencer

Abstract

This paper generalizes the standard homoscedastic macro-finance model by allowing for stochastic volatility, using the ‘square root’ specification of the mainstreamfinance literature. Empirically, this specification dominates the standard model because it is consistent with the square root volatility found in macroeconomic time series. Thus it establishes an important connection between the stochastic volatility of the mainstream finance model and macroeconomic volatility of the Okun (1971) - Friedman (1977) type. This research opens the way to a richer specification of both macroeconomic and term structure models, incorporating the best features of both macro-finance and mainstream-finance models.

Suggested Citation

  • Peter Spencer, 2007. "Stochastic Volatility in a Macro-Finance Model of the US Term Structure of Interest Rates 1961-2004," Discussion Papers 07/32, Department of Economics, University of York.
  • Handle: RePEc:yor:yorken:07/32
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    Cited by:

    1. Zhuoshi Liu & Peter Spencer, 2009. "An Admissible Term Structure Model Of Sovereign Yield Spreads With Macro Factors: The Case Of Brazilian Global Bonds," Manchester School, University of Manchester, vol. 77(s1), pages 108-125, September.
    2. Massimo Guidolin & Daniel L. Thornton, 2010. "Predictions of short-term rates and the expectations hypothesis," Working Papers 2010-013, Federal Reserve Bank of St. Louis.
    3. Ireland, Peter N., 2015. "Monetary policy, bond risk premia, and the economy," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 124-140.
    4. Spencer, Peter & Liu, Zhuoshi, 2010. "An open-economy macro-finance model of international interdependence: The OECD, US and the UK," Journal of Banking & Finance, Elsevier, vol. 34(3), pages 667-680, March.

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    Keywords

    Macro-finance; affine term structure; heteroscedasticity;

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