Estimating Term Structure Equations Using Macroeconomic Variables

25 Pages Posted: 3 Jan 2008

See all articles by Ray C. Fair

Ray C. Fair

Yale University - Cowles Foundation; Yale School of Management - International Center for Finance

Date Written: January 2008

Abstract

This paper begins with the expectations theory of the term structure of interest rates with constant term premia and then postulates how expectations of future short term interest rates are formed. Expectations depend in part on predictions from a set of VAR equations and in part on the current and two lagged values of the short term interest rate. The results suggest that there is relevant independent information in both the VAR equations' predictions and the current and two lagged values of the short rate. The model fits the long term interest rate data well, including the 2004-2006 period, which some have found a puzzle. The properties of the model are consistent with the response of the long term U.S. Treasury bond rate to surprise price and employment announcements. The overall results suggest that long term rates can be fairly well explained by modeling expectation formation of future short term rates.

Keywords: Term structure equations, Expectations theory

JEL Classification: E43

Suggested Citation

Fair, Ray C., Estimating Term Structure Equations Using Macroeconomic Variables (January 2008). Cowles Foundation Discussion Paper No. 1634; Yale Economics Department Working Paper No. 32; Yale ICF Working Paper No. 07-19. Available at SSRN: https://ssrn.com/abstract=1079990

Ray C. Fair (Contact Author)

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States
203-432-3715 (Phone)
203-432-6167 (Fax)

HOME PAGE: http://fairmodel.econ.yale.edu

Yale School of Management - International Center for Finance ( email )

Box 208200
New Haven, CT 06520
United States
203-432-3715 (Phone)
203-432-6167 (Fax)

HOME PAGE: http://fairmodel.econ.yale.edu

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