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Macro factors and the Term Structure of Interest Rates

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  • Dewachter, H.D.R.
  • Lyrio, M.

Abstract

This paper presents an essentially affine model of the term structure of interest rates making use of macroeconomic factors and their long-run expectations. The model extends the approach pioneered by Kozicki and Tinsley (2001) by modeling consistently long-run inflation expectations simultaneously with the term structure. This model thus avoids the standard pre-filtering of long-run expectations, as proposed by Kozicki and Tinsley (2001). Application to the U.S. economy shows the importance of long-run inflation expectations in the modelling of long-term bonds. The paper also provides a macroeconomic interpretation for the factors found in a latent factor model of the term structure. More specifically, we find that the standard "level" factor is highly correlated to long-run inflation expectations, the "slope" factor captures temporary business cycle conditions, while the "curvature" factor represents a clear independent monetary policy factor.

Suggested Citation

  • 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.
    • Handle: RePEc:ems:eureri:324
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    References listed on IDEAS

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    4. Qiang Dai & Kenneth J. Singleton, 2001. "Expectation Puzzles, Time-varying Risk Premia, and Dynamic Models of the Term Structure," NBER Working Papers 8167, National Bureau of Economic Research, Inc.
    5. Kozicki, Sharon & Tinsley, P. A., 2002. "Dynamic specifications in optimizing trend-deviation macro models," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1585-1611, August.
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    More about this item

    Keywords

    Essentially affine term structure model; long-run market expectations; macroeconomic factors; monetary policy rule;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G3 - Financial Economics - - Corporate Finance and Governance
    • M - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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