Uncertainty and the Term Structure of Interest Rates

Abstract

We present a new stylized fact about the link between uncertainty and the term structure of interest rates: Unexpectedly heightened uncertainty elicits a lower, steeper, and flatter yield curve. This result is established through a Yields-Macro model that includes dynamic Nelson-Siegel factors of U.S. Treasury yields, and accounts for endogenous feed back with observable measures of uncertainty, monetary policy, and macroeconomic aggregates. It is also robust to three distinct measures of uncertainty pertaining to the financial sector, the macroeconomy and economic policy. An efficient Bayesian algorithm for estimating the class of Yields-Macro models is also developed.

Keywords: Yield curve, Uncertainty, Monetary Policy, Dynamic Nelson-Siegel model, Bayesian estimation

JEL Classification: E43, E52, G01, G12