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Term Premium Dynamics and the Taylor RuleMichael F. GallmeyerUniversity of Virginia (UVA) - McIntire School of Commerce Burton HollifieldCarnegie Mellon University - David A. Tepper School of Business Francisco PalominoThe Stephen M. Ross School of Business at the University of Michigan Stanley E. ZinNew York University (NYU); National Bureau of Economic Research (NBER) February 15, 2009 EFA 2009 Bergen Meetings Paper Abstract: We explore the bond-pricing implications of an exchange economy where (i) preference shocks result in time-varying term premiums in real yields, and (ii) a monetary policy Taylor rule determines inflation and nominal term premiums. A calibrated version of the model matches the observed term structure of both the mean and volatility of yields. In addition, unlike a comparable model with exogenous inflation, a Taylor rule that matches the properties of observed inflation creates nominal term premiums that remain volatile even at long maturities. Experiments with different parameter values for the Taylor rule demonstrate that the nominal term premiums can be highly sensitive to monetary policy, and that the recent decrease in the level and volatility of the nominal yields could be the result of a more aggressive monetary policy.
Number of Pages in PDF File: 38 Keywords: Affine term structure, general equilibrium, time-varying term premiums, monetary policy JEL Classification: D51, E43, E52, G12 working papers seriesDate posted: February 17, 2009Suggested CitationContact Information
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