Do Term Premia Affect the Predictive Power of the German Yield Curve for Future Economic Activity?

Abstract:     
This paper presents and further analyses estimated term premia for Germany as the largest euro area country. The term premia are estimated within an affine arbitrage-free term structure model with two latent factors. Survey data help anchor model-implied long-horizon expectations for interest rates which have a large bearing on estimated term premia at the long-end of the yield curve in particular. The results suggest that term premia embedded in long-term interest rates displayed some cyclical variations over time. Moreover, term premia experienced a trend decline over the sample considered (1973 to 2006), but in particular since the mid-1990s. Hence, it may principally be important to take term premia developments explicitly into account when assessing the information content of the yield curve for future economic conditions or market expectations of future short-term interest rates, for example. This paper analyses empirically whether and to which extent term premia affected the predictive power of the slope of the yield curve for economic activity in Germany.

Number of Pages in PDF File: 24

Keywords: Yield curve, Term structure, Forecasting, Term premia, Financial markets and the macroeconomy

JEL Classification: E32, E43, E44, E47

working papers series