Government Policy Uncertainty and the Yield Curve
59 Pages Posted: 24 Sep 2015 Last revised: 23 Aug 2017
Date Written: August 23, 2017
We study the impact of economic policy uncertainty on the term structure of nominal interest rates. We develop a general equilibrium model, in which both the government and the central bank policy decisions are driven by uncertainty shocks. Our affine yield curve model captures both the shape of the interest rate term structure as well as the hump-shape of bond yield volatilities. Our theoretical predictions are strongly supported by the data. Higher economic policy uncertainty leads to a significant decline in yield levels, induces a hump-shaped increase in bond yield volatility, and increases bond risk premia, especially for longer maturities.
Keywords: Term structure modeling, yield volatility curve, policy uncertainty, bond risk premia
JEL Classification: G01, G12, G14, G18
Suggested Citation: Suggested Citation