Term Premium Dynamics and the Taylor Rule

38 Pages Posted: 17 Feb 2009

See all articles by Michael F. Gallmeyer

Michael F. Gallmeyer

University of Virginia (UVA) - McIntire School of Commerce

Burton Hollifield

Carnegie Mellon University - David A. Tepper School of Business

Francisco Palomino

University of Michigan, Stephen M. Ross School of Business

Stanley E. Zin

New York University (NYU); National Bureau of Economic Research (NBER)

Date Written: February 15, 2009

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.

Keywords: Affine term structure, general equilibrium, time-varying term premiums, monetary policy

JEL Classification: D51, E43, E52, G12

Suggested Citation

Gallmeyer, Michael F. and Hollifield, Burton and Palomino, Francisco and Zin, Stanley E., Term Premium Dynamics and the Taylor Rule (February 15, 2009). EFA 2009 Bergen Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1344819 or http://dx.doi.org/10.2139/ssrn.1344819

Michael F. Gallmeyer (Contact Author)

University of Virginia (UVA) - McIntire School of Commerce ( email )

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HOME PAGE: http://www.commerce.virginia.edu/faculty_research/facultydirectory/Pages/Gallmeyer.aspx

Burton Hollifield

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
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Francisco Palomino

University of Michigan, Stephen M. Ross School of Business ( email )

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Ann Arbor, MI MI 48109
United States

Stanley E. Zin

New York University (NYU) ( email )

Bobst Library, E-resource Acquisitions
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New York, NY 10003-711
United States

National Bureau of Economic Research (NBER) ( email )

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