An Extended Macro-Finance Model with Financial FactorsHansDewachterauthorLeonardoIaniaauthorThis paper extends the benchmark Macro-Finance model by introducing, next to the standard macroeconomic factors, additional liquidity-related and return forecasting factors. Liquidity factors are obtained from a decomposition of the TED spread while the return forecasting (risk premium) factor is extracted by imposing a single factor structure on the one-period expected excess holding returns. The model is estimated on US data using MCMC techniques. Two findings stand out. First, the model outperforms significantly most structural and non-structural Macro-Finance yield curve models in terms of cross-sectional fit of the yield curve. Second, we find that financial shocks, either in the form of liquidity or risk premium shocks have a statistically and economically significant impact on the yield curve. The impact of financial shocks extends throughout the yield curve and is most pronounced at the high- and intermediate frequencies.E43 - Interest Rates: Determination, Term Structure, and EffectsG12 - Asset Pricing ; Trading Volume ; Bond Interest RatesE44 - Financial Markets and the MacroeconomyC11 - Bayesian Analysis: General2009-10-02MPRA Paper