No-Arbitrage Taylor Rules

51 Pages Posted: 28 Sep 2007 Last revised: 3 Nov 2010

See all articles by Andrew Ang

Andrew Ang

BlackRock, Inc

Sen Dong

Columbia Business School - Economics Department

Monika Piazzesi

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

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Date Written: September 2007

Abstract

We estimate Taylor (1993) rules and identify monetary policy shocks using no-arbitrage pricing techniques. Long-term interest rates are risk-adjusted expected values of future short rates and thus provide strong over-identifying restrictions about the policy rule used by the Federal Reserve. The no-arbitrage framework also accommodates backward-looking and forward-looking Taylor rules. We find that inflation and output gap account for over half of the variation of time-varying excess bond returns and most of the movements in the term spread. Taylor rules estimated with no-arbitrage restrictions differ from Taylor rules estimated by OLS, and the resulting monetary policy shocks are somewhat less volatile than their OLS counterparts.

Suggested Citation

Ang, Andrew and Dong, Sen and Piazzesi, Monika, No-Arbitrage Taylor Rules (September 2007). NBER Working Paper No. w13448, Available at SSRN: https://ssrn.com/abstract=1017771

Andrew Ang (Contact Author)

BlackRock, Inc ( email )

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Sen Dong

Columbia Business School - Economics Department ( email )

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United States

Monika Piazzesi

University of Chicago - Booth School of Business ( email )

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Chicago, IL 60637
United States
773-834-3199 (Phone)
773-702-0458 (Fax)

National Bureau of Economic Research (NBER) ( email )

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