Decomposing the Term Structure of Interests Rates: Evidence from a Small Open Economy

45 Pages Posted: 8 Oct 2018

Date Written: September 30, 2018

Abstract

This paper uses Israeli data of inflation-indexed and nominal government bonds to estimate a discrete-time essentially affine term structure model. To estimate the model, I use a uniquely long-spanned sample of monthly real yields for the period of 01/1985-03/2018. The nominal yields data spans the period of 05/2001-03/2018. I document an unconditional upward sloping real term structure that the model ascribes to a rising real term premium while the average expected real short rates are relatively flat. A decomposition of the break-even inflation shows that the unconditional term structure of the inflation premium is increasing with maturity and most of the variance in the short end is due to expected inflation. However, in the long end, most of it is due to the inflation term premium.

Keywords: Affine term structure models, Inflation-indexed bonds, Israel, Inflation, Monetary policy

JEL Classification: G12, E43, E44, E52

Suggested Citation

Nathan, Daniel, Decomposing the Term Structure of Interests Rates: Evidence from a Small Open Economy (September 30, 2018). Available at SSRN: https://ssrn.com/abstract=3257797 or http://dx.doi.org/10.2139/ssrn.3257797

Daniel Nathan (Contact Author)

Bank of Israel ( email )

P.O. Box 780
Jerusalem, 91907
Israel

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