Reverse Engineering the Yield Curve

44 Pages Posted: 12 Jul 2000

See all articles by David K. Backus

David K. Backus

NYU Stern School of Business; National Bureau of Economic Research (NBER)

Stanley E. Zin

Carnegie Mellon University; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 1994

Abstract

Prices of riskfree bonds in any arbitrage-free environment are governed by a pricing kernel: given a kernel, we can compute prices of bonds of any maturity we like. We use observed prices of multi-period bonds to estimate, in a log-linear theoretical setting, the pricing kernel that gave rise to them. The high-order dynamics of our estimated kernel help to explain why first-order, one-factor models of the term structure have had difficulty reconciling the shape of the yield curve with the persistence of the short rate. We use the estimated kernel to provide a new perspective on Hansen-Jagannathan bounds, the price of risk, and the pricing of bond options and futures.

Suggested Citation

Backus, David K. and Zin, Stanley E., Reverse Engineering the Yield Curve (March 1994). NBER Working Paper No. w4676. Available at SSRN: https://ssrn.com/abstract=226965

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Stanley E. Zin

Carnegie Mellon University ( email )

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United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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