Theory and empirics of an affine term structure model applied to European data

Jakas, Vicente (2011): Theory and empirics of an affine term structure model applied to European data. Published in: Aestimatio. The IEB International Journal of Finance No. 2 (July 2011): pp. 1-18.

Abstract

The basic asset pricing equation is adapted to include the effects of unemployment, consumers’ expectations, the price level and money supply on money market rates and government bond yields. Expected consumption growth is modelled using European unemployment figures and Eurostat Consumer Confidence Index. The price level is incorporated in the aggregate marginal utility function using production price index (PPI) as a proxy. An affine term structure model is derived using a state space system with an observation equation which links observable yields to these macroeconomic variables and a state equation which describes the dynamics of these variables. Unemployment and consumer confidence index will have a shift and a slope effect on the yield curve, for front-end yields moving faster than in the long end. Production price index exhibits a twist effect (flattening or steepening of the curve) which results in front-end yields shifting in opposite directions to the long end of the curve. This empirical work shows that yields are negatively correlated to money supply, as expected in classical IS-LM models. And that money supply exhibits a slope effect, with the front-end of the curve shifting faster than the longer end.

• Item Type: MPRA Paper
• Language: English
• Keywords: Macroeconomic releases, Term structure of interest rates, Dynamic factors, Affine term structure models
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E12 - Keynes ; Keynesian ; Post-Keynesian; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy

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