Resolving the Spanning Puzzle in Macro-Finance Term Structure Models

50 Pages Posted: 5 Feb 2015

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: January 31, 2015

Abstract

Previous macro-finance term structure models (MTSMs) imply that macroeconomic state variables are spanned by (i.e., perfectly correlated with) model-implied bond yields. However, this theoretical implication appears inconsistent with regressions showing that much macroeconomic variation is unspanned and that the unspanned variation helps forecast excess bond returns and future macroeconomic fluctuations. We resolve this contradiction — or “spanning puzzle” — by reconciling spanned MTSMs with the regression evidence, thus salvaging the previous macro-finance literature. Furthermore, we statistically reject “unspanned” MTSMs, which are an alternative resolution of the spanning puzzle, and show that their knife-edge restrictions are economically unimportant for determining term premia.

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

JEL Classification: E430, E440, E520

Suggested Citation

Bauer, Michael and Rudebusch, Glenn D., Resolving the Spanning Puzzle in Macro-Finance Term Structure Models (January 31, 2015). CESifo Working Paper Series No. 5187, Available at SSRN: https://ssrn.com/abstract=2560719

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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