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A joint econometric model of macroeconomic and term structure dynamics

Author

Listed:
  • Tristani, Oreste
  • Vestin, David
  • Hördahl, Peter
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. JEL Classification: E43, E44, E47

Suggested Citation

  • Tristani, Oreste & Vestin, David & Hördahl, Peter, 2004. "A joint econometric model of macroeconomic and term structure dynamics," Working Paper Series 405, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:2004405
    Note: 24907
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    More about this item

    Keywords

    Affine term-structure models; new neo-classical synthesis; policy rules;
    All these keywords.

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications

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