Macro Factors and the Term Structure of Interest Rates
24 Pages Posted: 24 Mar 2003
Date Written: January 2004
This paper presents an essentially affine model of the term structure of interest rates making use of macroeconomic factors and their long-run expectations. The model extends the approach pioneered by Kozicki and Tinsley (2001) by modeling consistently long-run inflation expectations simultaneously with the term structure. Application to the U.S. economy shows the importance of long-run inflation expectations in the modeling of long-term bond yields. The paper also provides a macroeconomic interpretation for the latent factors found in standard finance models of the yield curve: the "level" factor represents the long-run inflation expectation of agents; the "slope" factor captures business cycle conditions; and the "curvature" factor expresses a clear independent monetary policy factor.
Keywords: Essentially affine term structure model, macroeconomic factors, long-run market expectations, monetary policy rule
JEL Classification: M, M41, G3, E43, E44, E52
Suggested Citation: Suggested Citation