Interest Rates under Falling Stars
53 Pages Posted: 23 Jan 2020
Date Written: October 23, 2019
Macro-finance theory implies that trend ination 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 in determining 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: E430, E440, E470
Suggested Citation: Suggested Citation