Interest Rates Under Falling Stars

American Economic Review, Forthcoming

51 Pages Posted: 18 Jul 2017 Last revised: 30 Nov 2019

See all articles by Michael Bauer

Michael Bauer

Universit├Ąt Hamburg

Glenn D. Rudebusch

Federal Reserve Bank of San Francisco

Multiple version iconThere are 2 versions of this paper

Date Written: October 23, 2019

Abstract

Macro-finance theory implies that trend inflation and the equilibrium real interest rate are fundamental determinants of the yield curve. However, empirical models of the term structure of interest rates generally assume that these fundamentals are constant. We show that accounting for time variation in these underlying long-run trends is crucial for understanding the dynamics of Treasury yields and predicting excess bond returns. We introduce a new arbitrage-free model that captures the key role that long-run trends play for interest rates. The model also provides new, more plausible estimates of the term premium and accurate out-of-sample yield forecasts.

Keywords: yield curve, macro-finance, inflation trend, equilibrium real interest rate, shifting endpoints, bond risk premia

JEL Classification: E43, E44, E47

Suggested Citation

Bauer, Michael and Rudebusch, Glenn D., Interest Rates Under Falling Stars (October 23, 2019). American Economic Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3001508 or http://dx.doi.org/10.2139/ssrn.3001508

Michael Bauer (Contact Author)

Universit├Ąt 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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