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Modelling the Term Structure with Trends in Yields and Cycles in Excess Returns

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  • Favero, Carlo A.
  • Fernandez-Fuertes, Ruben

Abstract

This paper proposes an Affine Macro Term Structure model in which yields are drifting, sharing a common stochastic trend driven by the drift in short-term (monetary policy) rates and excess returns are stationary as the compensation for risk is driven by the cycles in yields. We apply the approach to US data and compare the empirical results from the new specification with those obtained from standard Affine Term Structure models. The cycle-trend decomposition-based Affine Term Structure model produces much better forecasts of the dynamics of yields and, consequently, different and stationary dynamics for the term premia.

Suggested Citation

  • Favero, Carlo A. & Fernandez-Fuertes, Ruben, 2023. "Modelling the Term Structure with Trends in Yields and Cycles in Excess Returns," CEPR Discussion Papers 18590, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:18590
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    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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