Modena, Matteo (2008): Yield curve, time varying term premia, and business cycle fluctuations.
Download (485kB) | Preview
Using data for U.S. and Canada, we find evidence of the time-varying nature of risk premia, which are obtained as difference between long term interest rates and their expected values. We then apply Kalman filtering to extract the conditional variance of term premia prediction errors; our results highlight that this variable is informative beyond term premia and spreads, and it significantly improves upon prediction capability of standard models. In particular, the conditional variance of term premia, reflecting the high volatility of financial markets, anticipates movements in the output growth. Empirical evidence supports the inverse correlation between term premia and business cycle fluctuations. Data suggest that a deterioration of financial markets conditions, as captured by the increased volatility of term premia, anticipates a decline in the output growth. Therefore, term premia conditional volatility has an adverse effect on the economy.
|Item Type:||MPRA Paper|
|Original Title:||Yield curve, time varying term premia, and business cycle fluctuations|
|Keywords:||Term Structure; Term Premia; Kalman Filtering; Industrial Production Growth|
|Subjects:||E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations; Cycles
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy
C - Mathematical and Quantitative Methods > C0 - General > C01 - Econometrics
|Depositing User:||matteo modena|
|Date Deposited:||26. May 2008 18:17|
|Last Modified:||12. Feb 2013 10:04|
Ang A., Bekaert G., 2003, The Term Structure of Real Rates and Expected Inflation, Columbia University and NBER Working Papers.
Ang A., Piazzesi M., 2003, A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables, Journal of Monetary Economics, Vol. 50, n. 4, 745-787.
Ang A., Piazzesi M., Wei M., 2006, What Does the Yield Curve Tell Us about GDP Growth?, Journal of Econometrics, Vol. 131.
Backus K. D., Wright J. H., 2007, Cracking the Conundrum, Brooking Papers on Economic Activity, 1:2007.
Bagliano F., Favero C.A., 1997, Measuring Monetary Policy with VAR Models: an Evaluation, European Economic Review, Vol. 42, 1069-1112. . Bernanke B., 1990, On the Predictive Power of Interest Rates and Interest Rate Spreads, NBER Working Papers.
Breusch T.S., Pagan A.R., 1979, A Simple Test for Heteroscedasticity and Random Coefficients Variation, Econometrica, Vol. 47, 1287 - 1294.
Campbell J.Y., 1987, Stock Returns and the Term Structure, Journal of Financial Economics, Vol.18, 373 – 399.
Campbell J.Y., Shiller R.J., 1991, Yield Spreads and Interest Rate Movements: A Bird’s Eye View, The Review of Economic Studies, Vol. 58, n.3, 495-514.
Caporale G.M., Pittis N., 1998, Term Structure and Interest Differentials as Predictors of Future Inflation Changes and Inflation Differentials, Applied Financial Economics, Vol. 8, 615-625.
Cochrane J.H., 1999, New Facts in Finance, Economic Perspecives XXIII, Fed of Chicago.
Cochrane J.H., 2005, Asset Pricing, Princeton University Press.
Cochrane J.H. Piazzesi M., 2005, Bond Risk Premia, The American Economic Review, Vol. 95, n. 1, 138-160.
Cook T., Hahn T., 1989, Interest Rate Expectations and the Slope of the Money Market Yield Curve, Federal Reserve Bank of Richmond.
Cook T., Hahn T., 1989, The Effect of Changes in the Federal Funds Rate Target on Market Interest Rates in the 1970s, Journal of Monetary Economics, Vol. 24, 331-351.
Dueker M.J., 1997, Strengthening the Case for the Yield Curve as a Predictor of U.S. Recessions, Fed of Saint Louis Review, March/April.
Engle R.F., 1982, Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation, Econometrica, Vol. 50, 987 - 1007.
Engle R.F., Lilien D.M., Robins R.P., 1987, Estimating Time-Varying Risk Premia in the Term Structure: the ARCH-M Model, Econometrica, Vol. 55, 391 - 407.
Engle R.F., Watson M.W., 1985, Application of Kalman Filtering in Econometrics, unpublished report, World Congress of the Econometric Society. Cambridge, MA.
Estrella A., Hardouvelis G.A., 1991, The Term Structure as a Predictor of Real Economic Activity, The Journal of Finance, Vol. 46, n. 2, 555-576.
Estrella A., Mishkin F.S., 1997, The Predictive Power of the Term Structure of Interest Rates in Europe and the United States: Implications for the European Central Bank, European Economic Review, Vol. 41, 1375-1401.
Estrella A., Mishkin F.S., 1999, Predicting U.S. Recessions: Financial Variables as Leading Indicators, NBER Working Papers.
Evans C.L., Marshall D.A., 2007, Economic Determinants of the Nominal Treasury Yield Curve, Journal of Monetary Economics, Vol. 54, n. 7, 1986 – 2003.
Fama E.F., 1984, The Information in the Term Structure, Journal of Financial Economics, Vol. 13, 509-528.
Fama E.F., 1984, Term Premium in Bonds Returns, Journal of Financial Economics, Vol. 13, 529-546.
Fama E.F., 1986, Term Premiums and Default Premiums in Money Markets, Journal of Financial Economics, Vol. 17, 175-196.
Fama E.F., Bliss R.R., 1987, The Information in Long Maturity Forward Rates, The American Economic Review, Vol. 77, n. 4, 680-692.
Favero C.A., 2001, Does Macroeconomics Help Understand the Term Structure of Interest Rates?, Paper prepared for the Conference “EMU Macroeconomic Institutions and Policies”.
Favero C.A., 2006, Taylor Rules and the Term Structure, Journal of Monetary Economics, Vol. 53, 1377 - 1393.
Favero C.A., Kaminska I., Soderstrom U., 2005, The Predictive Power of the Yield Spread: Further Evidence and a Structural Interpretation, CEPR Discussion Paper.
Feroli M., 2004, Monetary Policy and the Information Content of the Yield Spread, Federal Reserve Board, Washington D.C., Finance and Economics Discussion Series.
Hamilton J.D., Kim D.H., 2002, A Reexamination of the Predictability of Economic Activity Using the Yield Spread, Journal of Money, Credit, and Banking, Vol. 34, 340 – 360.
Hansen B.E., 1992, Testing for Parameter Instability in Linear Models, Journal of Policy Modeling, Vol. 14, n. 4, 517 – 533.
Hardouvelis G.A., 1988, The Predictive Power of the Term Structure During Recent Monetary Regimes, The Journal of Finance, Vol. 43, n. 2, 339-356.
Hardouvelis G.A., 1994, The Term Structure Spread and Future Changes in Long and Short Rates in G-7 Countries: Is There a Puzzle?, Journal of Monetary Economics, Vol. 33, 255-283.
Hejazi W., Li Z., 2000, Are Forward Premia Mean Reverting?, Applied Financial Economics, Vol. 10, 343 – 350.
Hejazi W., 2000, Yield Spreads as Predictors of Industrial Production: Expectations on Short Rates or Term Premia?, Applied Economics, Vol. 32, 945 - 951.
Hejazi W., Lai H., Yang X., 2000, The Expectations Hypothesis, Term Premia, and the Canadian Term Structure of Interest Rates, Canadian Journal of Economics, Vol. 33, 133 – 148.
Kim C.J., Nelson C.R., 1989, The Time-Varying-Parameter Model for Modeling Changing Conditional Variance: the Case of the Lucas Hypothesis, Journal of Business & Economic Statistics, Vol. 7, 433 – 440.
Kim D., Wright J.H., 2005, An Arbitrage-Free Three-Factor Term Structure Model and the recent Behaviour of Long-Term Yields and Distant-Horizon Forward Rates, Fed Working Paper.
Kozicki S., Sellon G., 2005, Longer-Term Perspectives on the Yield Curve and Monetary Policy, Fed of Kansas City Working Paper.
Lee S.S., 1995, Macroeconomic Sources of Time-Varying Risk Premia in the Term Structure of Interest Rates, Journal of Money, Credit and Banking, Vol. 27, n.2, 549-569.
Mankiw N.J., Miron J.A., 1986, The Changing Behaviour of the Term Structure of Interest Rates, The Quarterly Journal of Economics, Vol. 101, n. 2, 211-228.
Miskin F.S., 1982, Does Anticipated Monetary Policy Matters? An Econometric Investigation, The Journal of Political Economy, Vol. 90, 22 – 51.
Miskin F.S., 1988, The Information in the Term Structure: Some Further Results, Journal of Applied Econometrics, Vol. 3, n. 4, 307-314.
Miskin F.S., 1988, What Does the Term Structure Tell Us About Future Inflation?, NBER Working Paper.
Pagan A., 1984, Econometric Issues in the Analysis of Regressions with Generated Regressors, International Economic Review, Vol. 25, 221 – 247.
Pesando J.E., Determinants of Term Premiums in the Market for United States Treasury Bills, The Journal of Finance, Vol. 30, 1317 - 1327.
Rudebusch G.D., Wu T., 2004, A Macro-Finance Model of the Term Structure, Monetary Policy, and the Economy, Fed of San Francisco Working Paper.
Rudebusch G.D., Sack B.P., Swanson E.T., 2007, Macroeconomic Implications of Changes in the Term Premia, Fed of St Louis Review.
Schwert G. W., 1989, Business Cycles, Financial Crises, and Stock Volatility, Carnegie Rochester Conference Series on Public Policy, Vol. 31, 83-126.
Stock, J.H., Watson M.W., 1989, New Indexes of Coincident and Leading Indicators, In Blanchard O., Fischer S., NBER Macroeconomics Annual, Vol. 4, MIT Press.
Thornton D.L., 2003, Tests of the Expectations Hypothesis: Resolving the Campbell-Shiller Paradox, Fed of St. Louis Working Paper.
Tzavalis E., Wickens M. R., 1997, Explaining the Failures of the Term Spread Models of Rational Expectations Hypothesis of the Term Structure, Journal of Money, Credit and Banking, Vol. 29, n. 3, 364-380.
Wright J.H., 2006, The Yield Curve and Predicting Recessions, Fed Working Paper.