Challenges in Macro-Finance Modeling

Posted: 2 Jul 2021

See all articles by Don H. Kim

Don H. Kim

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: 2008

Abstract

This paper discusses various challenges in the specification and implementation of ?macro-finance? models in which macroeconomic variables and term structure variables are modeled together in a no-arbitrage framework. I classify macro-finance models into pure latent-factor models (?internal basis models?) and models which have observed macroeconomic variables as state variables (?external basis models?), and examine the underlying assumptions behind these models. Particular attention is paid to the issue of unspanned short-run fluctuations in macro variables and their potentially adverse effect on the specification of external basis models. I also discuss the challenge of addressing features like structural breaks and time-varying inflation uncertainty. Empirical difficulties in the estimation and evaluation of macro-finance models are also discussed in detail.

Suggested Citation

Kim, Don H., Challenges in Macro-Finance Modeling (2008). FEDS Working Paper No. 2008-6, Available at SSRN: https://ssrn.com/abstract=3877822

Don H. Kim (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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