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Abstract:
Through explicitly incorporating analysts' forecasts as observable factors in a dynamic arbitrage-free model of the yield curve, this paper proposes a framework for studying the impact of shifts in market sentiment on interest rates of all maturities. An empirical examination reveals that survey expectations about inflation, output growth and the anticipated path of monetary policy actions contain important information for explaining movements in bond yields. Estimates from a forward-looking monetary policy rule suggest that the central bank exhibits a preemptive response to inflationary expectations, while accommodating output growth and monetary policy expectations. Forecasted GDP growth plays a significant role in explaining time-variation in the market prices of risk. The sensitivity of long yields are explained by the persistence of expected inflation under the risk-neutral measure. Models of this type may provide traders and policymakers with a new set of tools for formally assessing the reaction of bond yields to shifts in market expectations.

term structure, interest rates, affine model, forward-looking policy rules, macro-finance, no-arbitrage, blue chip forecasts, survey data

Abstract:
Survey forecasts of interest rates and inflation are of importance to traders, financial managers and monetary policy makers, many of whom subscribe to and depend on these forecasts to anchor important decisions. This study examines the forecasting performance of the individual participants in the Blue Chip Financial Forecasts - a unique collection of cross-sectional time series survey data on interest rates and inflation. The performance of the surveys is compared with a set of econometric models including those that employ parameter shrinkage. An empirical examination reveals that fed funds futures prices best predict the fed funds rate at very short horizons, and that survey forecasters are competitive at short horizon forecasts of short to medium maturity interest rates. An enhanced version of the Diebold-Li model with VAR(3) dynamics and shrinkage toward the long run mean emerges as the best performing model for long horizon forecasts of yields up to 2 years. For forecasting 5 and 10-year maturity yields, simple autoregressive models with shrinkage dominate. Individual survey forecasters, including the mean forecaster, do particularly well at forecasting inflation.

Qrinkage, Forecast Evaluation, Term Structure of Interest Rates, Bond Yields, Model Confidence Sets, Survey Data

Abstract:
This paper presents a reduced form model for the valuation of variable-coupon bonds where the coupon rate fluctuates with the credit rating of the issuing firm. We work within a class of intensity based pricing models where a Cox (or a doubly stochastic Poisson) process governs the intensity of the ratings change. The time-variation in the credit transition process is modeled via a continuous-time inhomogeneous Markov chain. With a desire to avoid making strong assumptions on the properties of the generator matrix, we develop a general recursive pricing model. As a special case, we derive essentially closed form solutions for the prices of step-up only bonds within an affine term structure setting.

step-up bond, affine term structure, credit-sensitive bond