Evolving Macroeconomic Perceptions and the Term Structure of Interest Rates

55 Pages Posted: 5 Mar 2011

See all articles by Min Wei

Min Wei

Board of Governors of the Federal Reserve - Division of Monetary Affairs

Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: April 14, 2008

Abstract

We explore the role of evolving beliefs regarding the structure of the macroeconomy in improving our understanding of the term structure of interest rates within the context of a simple macro-finance model. Using quarterly vintages of real-time data and survey forecasts for the United States over the past 40 years, we show that a recursively estimated VAR on real GDP growth, inflation and the nominal short-term interest generates predictions that are more consistent with survey forecasts than a benchmark fixed-coefficient counterpart. We then estimate a simple term structure model under the assumption that the investors' risk attitude is driven by near-term expectations of the three state variables. When we allow for evolving beliefs about the macroeconomy, the resulting term structure model provides a better fit to the cross section of yields than the benchmark model, especially at longer maturities, and exhibits better performance in out-of-sample predictions of future yield movements.

Keywords: Macro Term Structure Model, Recursive VAR, Survey Forecasts, Anticipated Utility

JEL Classification: E43, E44, E47, G12

Suggested Citation

Wei, Min and Orphanides, Athanasios, Evolving Macroeconomic Perceptions and the Term Structure of Interest Rates (April 14, 2008). FEDS Working Paper No. 2010-01. Available at SSRN: https://ssrn.com/abstract=1777242 or http://dx.doi.org/10.2139/ssrn.1777242

Min Wei

Board of Governors of the Federal Reserve - Division of Monetary Affairs ( email )

20th and C Streets, NW
Washington, DC 20551
United States

Athanasios Orphanides (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=54058

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