Imperfect Information, Macroeconomic Dynamics and the Yield Curve: An Encompassing Macro-Finance Model

National Bank of Belgium Working Paper No. 144

71 Pages Posted: 1 Oct 2010

See all articles by Hans Dewachter

Hans Dewachter

Catholic University of Leuven (KUL) - Department of Economics; Erasmus Research Institute of Management (ERIM)

Date Written: October 16, 2008

Abstract

In this paper we estimate an encompassing Macro-Finance model allowing for time variation in the equilibrium real rate, mispricing and learning dynamics. The encompassing model specification incorporates (i) a small-scale (semi-) structural New-Keynesian model, (ii) flexible price of risk specifications, (iii) liquidity premiums in the form of (constant) deviations from (Gaussian) no-arbitrage and (iv) learning dynamics. This model is estimated on US data using MCMC techniques. We find that the encompassing model outperforms significantly standard Macro-Finance models in terms of marginal likelihood and BIC. Three findings stand out. First, unlike standard Macro-Finance models, a substantial fraction of the variation in long-term yields is attributed to changes in the perceived equilibrium real rate. Second, statistically and economically significant learning effects, especially for inflation expectations, are found. Finally, historical decompositions show that the model can replicate the US yield curve dynamics over the period 1960-2007.

Keywords: Imperfect information, New-Keynesian macroeconomic dynamics, equilibrium real rate, affine yield curve models

JEL Classification: E43, E44, E52

Suggested Citation

Dewachter, Hans, Imperfect Information, Macroeconomic Dynamics and the Yield Curve: An Encompassing Macro-Finance Model (October 16, 2008). National Bank of Belgium Working Paper No. 144, Available at SSRN: https://ssrn.com/abstract=1685155 or http://dx.doi.org/10.2139/ssrn.1685155

Hans Dewachter (Contact Author)

Catholic University of Leuven (KUL) - Department of Economics ( email )

Center for Economic Studies
Naamsestraat 69
Leuven, B-3000
Belgium
+0032 16 326859 (Phone)
+0032 16 326796 (Fax)

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

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