64 Pages Posted: 7 Feb 2015 Last revised: 22 Sep 2016
Date Written: September 20, 2016
We propose a no-arbitrage term structure model with a Taylor rule and two macroeconomic variables, real activity growth and inflation, that each contain long-run and short-run components. Variance decompositions and impulse responses indicate that the impact of macroeconomic variables on the term structure differs from existing models. For short maturities, inflation is relatively more important than real activity growth at short forecast horizons. For longer maturity yields, the long-run component of inflation explains most of the long-horizon forecast variance, but real activity growth matters for short forecast horizons. Unlike existing macro models, the model implies plausible term premia and expectations of short rates. The long-run components also improve the prediction of bond excess returns relative to information in the yield curve and macro variables. Measures of in-sample and out-of-sample fit confirm the benefits of allowing for long- and short-run components.
Keywords: term structure; inflation; real activity growth; long-run component; filtering
JEL Classification: G12, E43, E44
Suggested Citation: Suggested Citation
Doshi, Hitesh and Jacobs, Kris and Liu, Rui, Macroeconomic Determinants of the Term Structure: Long-Run and Short-Run Dynamics (September 20, 2016). Available at SSRN: https://ssrn.com/abstract=2561026 or http://dx.doi.org/10.2139/ssrn.2561026
By Meb Faber