Estimation of a Joint Model for the Term Structure of Interest Rates and the Macroeconomy

Journal of Applied Econometrics, Vol. 21, No. 4, pp. 439-462, 2006

60 Pages Posted: 1 Sep 2001

See all articles by Hans Dewachter

Hans Dewachter

Catholic University of Leuven (KUL) - Department of Economics; Erasmus Research Institute of Management (ERIM)

Marco Lyrio

Insper Institute of Education and Research

Stan Maes

European Commission - DG Internal market and financial services; European Commission - DG Competition; KU Leuven - Department of Economics

Abstract

In this paper, we present a stylized continuous time model integrating the macroeconomy and the bond markets. We use this framework to estimate (real) interest rate policy rules using information contained in both macroeconomic variables (i.e. output and inflation) and in the term structure of interest rates. We extend the standard Kalman filter procedure in order to estimate this model efficiently. Application to the U.S. economy shows that this model is able to estimate the macroeconomic dynamics accurately and that the standard feedback rule only in observable factors is not valid within this framework. Moreover, we find that observable macroeconomic variables do not explain much of the term structure. However, (filtered) stochastic central tendencies of these macroeconomic variables do. Finally, both observable and non-observable factors determine the risk premia and hence the excess holding returns of the bonds.

Keywords: Essentially affine term structure model, feedback interest rate rule, forecasting

JEL Classification: E43, E44, E52

Suggested Citation

Dewachter, Hans and Lyrio, Marco and Maes, Konstantijn, Estimation of a Joint Model for the Term Structure of Interest Rates and the Macroeconomy. Journal of Applied Econometrics, Vol. 21, No. 4, pp. 439-462, 2006, Available at SSRN: https://ssrn.com/abstract=281511 or http://dx.doi.org/10.2139/ssrn.281511

Hans Dewachter (Contact Author)

Catholic University of Leuven (KUL) - Department of Economics ( email )

Center for Economic Studies
Naamsestraat 69
Leuven, B-3000
Belgium
+0032 16 326859 (Phone)
+0032 16 326796 (Fax)

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Marco Lyrio

Insper Institute of Education and Research ( email )

R Quata 300
Sao Paulo, 04542-030
Brazil

HOME PAGE: http://www.insper.edu.br/en/faculty-and-research/marco-lyrio

Konstantijn Maes

European Commission - DG Internal market and financial services ( email )

Rue de la Loi 200
Brussels, B-1049
Belgium

European Commission - DG Competition ( email )

Place Madou, Madouplein 1
Saint-Josse-ten-Noode/Sint-Joost-ten-Noode
Brussels, B-1049
Belgium

KU Leuven - Department of Economics ( email )

Naamsestraat 69
2nd Floor
B-3000 Leuven
Belgium

HOME PAGE: http://www.econ.kuleuven.ac.be/ew/academic/intecon

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