A Joint Econometric Model of Macroeconomic and Term Structure Dynamics

68 Pages Posted: 13 Dec 2004

See all articles by Peter Hördahl

Peter Hördahl

Bank for International Settlements (BIS) - BIS Representative Office for Asia and the Pacific

Oreste Tristani

European Central Bank (ECB)

David Vestin

European Central Bank (ECB)

Date Written: November 2004

Abstract

We construct and estimate a joint model of macroeconomic and yield curve dynamics. A small-scale rational expectations model describes the macroeconomy. Bond yields are affine functions of the state variables of the macromodel, and are derived assuming absence of arbitrage opportunities and a flexible price of risk specification. While maintaining the tractability of the affine set-up, our approach provides a way to interpret yield dynamics in terms of macroeconomic fundamentals; time-varying risk premia, in particular, are associated with the fundamental sources of risk in the economy. In an application to German data, the model is able to capture the salient features of the term structure of interest rates and its forecasting performance is often superior to that of the best available models based on latent factors. The model has also considerable success in accounting for features of the data that represent a puzzle for the expectations hypothesis.

Keywords: Affine term-structure models, policy rules, new neo-classical synthesis

JEL Classification: E43, E44, E47

Suggested Citation

Hoerdahl, Peter and Tristani, Oreste and Vestin, David, A Joint Econometric Model of Macroeconomic and Term Structure Dynamics (November 2004). ECB Working Paper No. 405; AFA 2005 Philadelphia Meetings Paper, Available at SSRN: https://ssrn.com/abstract=601025 or http://dx.doi.org/10.2139/ssrn.601025

Peter Hoerdahl (Contact Author)

Bank for International Settlements (BIS) - BIS Representative Office for Asia and the Pacific ( email )

78th floor, Two International Finance Centre
8 Finance Street, Central
Hong Kong

Oreste Tristani

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0049 69 1344 6000 (Fax)

David Vestin

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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