An Extended Macro-Finance Model with Financial Factors
58 Pages Posted: 2 Oct 2009 Last revised: 2 Sep 2012
Date Written: November 1, 2009
This paper extends the benchmark Macro-Finance model by introducing, next to the standard macroeconomic factors, additional liquidity-related and return forecasting factors. Liquidity factors are obtained from a decomposition of the TED spread while the return-forecasting (risk premium) factor is extracted by imposing a single factor structure on the one-period expected excess holding returns. The model is estimated on US data using MCMC techniques. Two findings stand out. First, the model outperforms significantly most structural and non-structural Macro-Finance yield curve models in terms of cross-sectional fit of the yield curve. Second, we find that financial shocks, either in the form of liquidity or risk premium shocks, have a statistically and economically significant impact on the yield curve. The impact of financial shocks extends throughout the yield curve but is most pronounced at the high and intermediate frequencies.
Keywords: Yield Curve, Affine Models, Macroeconomics and Financial Factors, Bayesian Estimaion
JEL Classification: C11, E44, G12
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