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.
Download (1MB) | Preview
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|
|Original Title:||Theory and empirics of an affine term structure model applied to European data|
|English Title:||Theory and empirics of an affine term structure Model Applied to European Data|
|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
|Depositing User:||IEB Research Department|
|Date Deposited:||18. Jan 2012 16:55|
|Last Modified:||17. Mar 2015 23:04|
Allen, F. and Gale, D. (2000), Asset Price Bubbles and Monetary Policy, in Proceedings of Sveriges Riksbank-Stockholm School of Economics Conference on Asset Markets and Monetary Policy, Stockholm. Available at www.ssrn.com.
Ang, A., Dong, S. and Piazzesi, M. (2004). A no-arbitrage Taylor Rules, working Paper, University of Chicago, Chicago.
Ang, A. and Piazzesi, M. (2003). A no-arbitrage vector auto-regression of the term structure dynamics with macroeconomic and latent variables, Journal of Monetary Economics, 50(1), pp. 745-787.
Battini, N. and Haldane, A.G. (1999). Forward-looking rules for monetary policy, in Taylor, J.B. (Ed.) Monetary Policy Rules. University of Chicago Press for NBER, Chicago.
Bekaert, G., Cho, S. and Moreno, A. (2003). New Keynesian Macroeconomics and the term structure, working paper, Columbia University, Columbia.
Bernanke, B. (1990). On the Predictive Power of Interest Rates And Interest Rate Spreads, working paper No. 3486, National Bureau of Economic Research.
Bernanke, B. (2002). Monetary Policy in a data-rich environment, Journal of Monetary Economics, 50(2003), pp. 525-546.
Bernanke, B. and Mihov, I. (1998). Measuring Monetary Policy, Quarterly Journal of Economics, 113(3), pp. 869-902.
Breeden, D. T. (1979) An Intertemporal Asset Pricing Model with Stochastic Consumption and Investment Opportunities, Journal of Financial Economics, 7(1), pp. 265-296.
Clarida, R., Galí, J. and M. Gertler (1999). The science of monetary policy: a new Keynesian perspective, Journal of Economic Literature, 37, pp. 1661-1707.
Clarida, R., Galí, J. and M. Gertler (2002). Macroeconomic Policy Rules and Macroeconomic Stability: Evidence and Some Theory, Quarterly Journal of Economics, 115, pp. 147-180.
Cochrane, J. H. (2001). Asset Pricing, Princeton University Press, Princeton, New Jersey. Page 10.
Cook, T., and Hahn, T. (1989). The Effect of Changes in the Federal Funds Rate Target on Market Interest Rates in the 1970s, The Journal of Monetary Economics, November, pp. 331-351.
Diebold, F.X. and Li, C. (2006). Forecasting the Term Structure of Government Bond Yields, Journal of Econometrics, 130, pp. 337-364.
Diebold, F. X., Li, C. and Yue, V. (2005a). Modelling Term Structures of Global Bond Yields, working paper, University of Pennsylvania, PA.
Diebold, F. X., Rudebush, G. D. and Aruoba, S. B. (2005b). The Macroeconomy and the Yield Curve: A Dynamic Latent Factor Approach, Journal of Econometrics, 131(2006), pp. 309-338.
Dewachter, H. and Lyrio, M. (2002). Macro factors and the Term Structure of Interest Rates, Working Paper, Catholic University of Leuven, Belgium. Manuscript published in ww.ssrn.com.
Engle, R.F. and Granger, C.W.J. (1987). Co-integration and Error Correction: Representation, Estimation and Testing, Econometrica, 55, pp. 251-76.
Gerdesmeier, D. and Roffia, B. (2003). Empirical Estimates of Reaction Functions for the Euro Area, working paper No. 206, European Central Bank, Frankfurt am Main.
Gerlach-Kirsten, P. (2003). Interest Rate Reaction Functions and the Taylor Rule in the Euro Area, ECB Working Paper No. 258, Frankfurt am Main.
Gerlach, S and Schnabel, G. (1999). The Taylor Rule and Interest Rates in the EMU Area: A Note, BIS Working Paper No. 73, Basle.
Guvenen, F. and Lustig, H. (2007). Consumption Based Asset Pricing Models: Theory, working paper available at http://ssrn.com/abstract=968061, University of California, Los Angeles, CA.
Guvenen, F. and Lustig, H. (2007). Consumption Based Asset Pricing Models: Empirical, working paper available at http://ssrn.com/abstract=968063, University of California, Los Angeles, CA.
Gürkaynak, R. S., Sack, B. and Swanson, E. (2003). The excess sensitivity of long-term interest rates: evidence and implications for macroeconomic models, Board of Governors of the Federal Reserve System, manuscript.
Hamalainen, N. (2004). A Survey of Taylor Type Monetary Policy Rules, Working Paper 2004-02, Canadian Department of Finance.
Hayo, B. and Hofmann, B. (2003). Monetary Policy Reaction Functions: ECB versus Bundesbank, ZEI Working Paper, Bonn.
Hördahl, P., Tristani, P. and Vestin, D. (2003). A joint econometric model of macroeconomic and the term structure dynamics, working paper, European Central Bank.
King, R.G., Plosser, C.I., Stock, S.H., and Watson, M.W. (1991). Stochastic Trends and Economic Fluctuations, American Economic Review, 81, pp. 819-40.
Lucas, R. (1978) Asset Prices in an Exchange Economy, Econometrica, 46(6), pp. 1429-54.
Mc Callum B.T. (1990b). An Optimising IS-LM specification for monetary policy and business cycle analysis, Journal of Money Credit and Banking, 31, pp. 296-317.
Nelson, C. R., and Siegel, A. (1987). Parsimonius Modeling of Yield Curves, Journal of Business, 60(4), pp. 473-489.
Orphanides, A. (1998). Monetary Policy Evaluation with Noisy Information, Finance and Economics Discussion Series Working Paper, No. 1998-50, Board of Governors of the Federal Reserve System.
Pesaran, M.H., Shin, Y. and Smith, R.J. (1996). Testing for the Existence of a Long-Run Relationship, DAE Working Paper No. 9622, Department of Applied Economics, University of Cambridge.
Pesaran, M.H., Shin, Y. (1995) An Autoregressive Distributed Lad Modelling Approach to Cointegration Analysis, DAE Working Paper No. 9514, Department of Applied Economics, University of Cambridge, in S. Strom, A. Holly and P. Diamond (Eds.) Centennial volume of Rangar Frisch, Econometric Society Monograph, Cambridge, Cambridge University Press.
Piazzesi, M. and M. Schneider (2006). Equilibrium Yield Curves, working paper 12609, National Bureau of Economic Research, Cambridge, MA. Available at http://www.nber.org\papers\w12609.
Piazzesi, M. (2005). Bond Yields and the Federal Reserve, Journal of Political Economy, 113 (2). pp. 311-44.
Piazzesi, M. (2010). Affine Term Structure Models, in Ait-Sahalia, Y. and Hansen, Lars (Eds.) Handbook of Financial Econometrics, Elsevier BV, Amsterdam.
Rotemberg, J.J. and Woodford, M. (1997). An Optimisation-Based Econometric Framework for the Evaluation of Monetary Policy, in Bernanke, B. and J. Rotemberg (editors): NEBR Macroeconomics Annual 1997, 297-346.
Rubinstein, M. (1976) The valuation of uncertain income streams and the pricing of options. Bell Journal of Economics, 7, pp. 407-425.
Rudebusch, G. D. (2002) Term Structure evidence on interest rate smoothing and monetary policy inertia, Journal of Monetary Economics, 49, pp. 1161-1187.
Rudebusch, G. D. and Svensson, L.E.O. (1999). Policy Rules for Inflation Targeting, in John B. Taylor (ed.) Monetary Policy Rules, University of Chicago Press, Chicago.
Rudebusch, G. D. and Wu, T. (2003). A macro finance model of the term structure, monetary policy and the economy, working paper, Federal Reserve Bank of San Francisco.
Rudebusch, G. D. and Wu, T. (2004b). Accounting for a Shift in Term Structure Behaviour with No-Arbitrage and Macro-Finance Models, working paper, Federal Reserve Bank of San Francisco.
Smith, J. M. and Taylor, B. (2007). The Long and the Short End of the Term Structure of Policy Rules, Stanford University. Available at SSRN website.
Stock, J. H. and Watson, M.W. (1989). New indexes of coincident and leading economic indicators, NBER Macroeconomic Annual 4, MIT Press Cambridge, MA.
Taylor, J.B. (1993). Discretion versus policy rules in practice, Carnegie-Rochester Conference Series on Public Policy, 39, pp. 195-214.
Turnovsky, S. J. (1989). The Term Structure of Interest Rates and the Effects of Macroeconomic Policy, Working Paper No. 2920, NBER.