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The US Economy, the Treasury Bond Market and the Specification of Macro-Finance Models

  • Peter Spencer

This paper addresses questions about the structure of the economy and financial markets raised by recent research on the term structure. The work of Duffee (2012) and Joslin, Preibsch and Singleton (2012) suggests that macroeconomic variables affect risk premia rather than bond yields, which are driven by just three factors as in the traditional model. This is consistent with the observation that the real world macro-dynamics appear to be much richer than the risk neutral dynamics underpinning the term structure. On the other hand, Cochrane and Piazzesi (2005) and (2010) suggest that premia are much simpler, depending upon a single return forecasting factor but not macro variables. This paper suggests that the traditional model is too restrictive, performing poorly at the long end. A model with two return-forecasting factors works remarkably well.

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Paper provided by Department of Economics, University of York in its series Discussion Papers with number 13/22.

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Date of creation: Aug 2013
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Handle: RePEc:yor:yorken:13/22
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  1. Adrian, Tobias & Crump, Richard K. & Moench, Emanuel, 2013. "Pricing the term structure with linear regressions," Journal of Financial Economics, Elsevier, vol. 110(1), pages 110-138.
  2. Hendry, David F., 1995. "Dynamic Econometrics," OUP Catalogue, Oxford University Press, number 9780198283164, March.
  3. Hans Dewachter & Leonardo Iania, 2010. "An Extended Macro-Finance Model with Financial Factors," CESifo Working Paper Series 2950, CESifo Group Munich.
  4. Scott Joslin & Anh Le & Kenneth J. Singleton, 2013. "JFEC Invited Paper: Gaussian Macro-Finance Term Structure Models with Lags," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 11(4), pages 581-609, September.
  5. repec:cup:jfinqa:v:46:y:2011:i:06:p:1893-1916_00 is not listed on IDEAS
  6. Chernov, Mikhail & Mueller, Philippe, 2008. "The Term Structure of Inflation Expectations," CEPR Discussion Papers 6809, C.E.P.R. Discussion Papers.
  7. Ang, Andrew & Piazzesi, Monika, 2003. "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.
  8. Peter N. Ireland, 2005. "Changes in the Federal Reserve's inflation target: causes and consequences," Working Papers 05-13, Federal Reserve Bank of Boston.
  9. John Williams & Eric Swanson, 2012. "Measuring the Effect of the Zero Lower Bound on Medium- and Longer-Term Interest Rates," 2012 Meeting Papers 462, Society for Economic Dynamics.
  10. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
  11. Hans Dewachter & Marco Lyrio & Konstantijn Maes, 2001. "A Joint Model for the Term Structure of Interest Rates and the Macroeconomy," International Economics Working Papers Series wpie002, Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics.
  12. Bikbov, Ruslan & Chernov, Mikhail, 2010. "No-arbitrage macroeconomic determinants of the yield curve," Journal of Econometrics, Elsevier, vol. 159(1), pages 166-182, November.
  13. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, vol. 95(1), pages 425-436, March.
  14. 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.
  15. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 627-627, November.
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