Resolving the Spanning Puzzle in Macro-Finance Term Structure Models

Review of Finance, 2016

56 Pages Posted: 3 Nov 2014 Last revised: 26 Jan 2017

See all articles by Michael Bauer

Michael Bauer

Universität Hamburg

Glenn D. Rudebusch

Federal Reserve Bank of San Francisco

Multiple version iconThere are 2 versions of this paper

Date Written: May 12, 2016

Abstract

Most existing macro-finance term structure models (MTSMs) appear incompatible with regression evidence of unspanned macro risk. This “spanning puzzle” appears to invalidate those models in favor of new unspanned MTSMs. However, our empirical analysis supports the previous spanned models. Using simulations to investigate the spanning implications of MTSMs, we show that a canonical spanned model is consistent with the regression evidence; thus, we resolve the spanning puzzle. In addition, direct likelihood-ratio tests find that the knife-edge restrictions of unspanned models are rejected with high statistical significance, though these restrictions have only small effects on cross-sectional fit and estimated term premia.

Keywords: yield curve, term structure models, macro-finance, unspanned macro risk, monetary policy

JEL Classification: E43, E44, E52

Suggested Citation

Bauer, Michael and Rudebusch, Glenn D., Resolving the Spanning Puzzle in Macro-Finance Term Structure Models (May 12, 2016). Review of Finance, 2016, Available at SSRN: https://ssrn.com/abstract=2518037 or http://dx.doi.org/10.2139/ssrn.2518037

Michael Bauer (Contact Author)

Universität Hamburg ( email )

Von-Melle-Park 5
Hamburg, 20146
Germany

HOME PAGE: http://www.michaeldbauer.com

Glenn D. Rudebusch

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

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