A Forward-looking Model of the Term Structure of Interest Rates

Albert Lee Chun

Research output: Working paperResearch

Abstract

This article proposes a framework that facilitates the inclusion of a generalized structure of observable, forward-looking factors into a dynamic term structure model. We illustrate our framework using multi-horizon survey forecasts of inflation, output growth and monetary policy where the dynamics of the forecasts are modeled jointly with the physical process driving their realizations. We extend this framework to allow for multiple-horizon forecasts to drive the short rate, yielding its novel interpretation as a forward-looking multiple-horizon monetary policy rule, which facilitates a decomposition of monetary policy and the yield curve into short and long horizon expectations. While short horizon forecasts can pin down the short rate, long horizon forecasts embed information that better describes longer maturity yields. In addition, short horizon forecasts of real output growth are obscured in the cross section of yields, while long horizon forecasts are strongly manifest in the slope of the yield curve. We conclude by exploring the models' implications for bond risk premia. Our models may provide central banks and market participants with a tool for linking patterns in the multiple-horizon structure of market expectations, including those imputed to forward guidance, on the yield curve.
Original languageEnglish
Place of Publicationwww
PublisherSSRN: Social Science Research Network
Number of pages45
Publication statusPublished - 2012

Keywords

  • Affine Term Structure Models
  • Multiple-horizon forward-looking Monetary Policy Rule
  • Forecast Based Policy Rule
  • Bond Risk Premia
  • Blue Chip Financial Forecasts
  • Survey Expectations
  • Macro-finance
  • Yield Curve

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