What does the level of the real interest rates tell us about where the economy, or one’s portfolio, is headed? The answer to this question depends on one’s estimate of the “equilibrium ” value of real interest rates, a measure that is unfortunately not directly observed in the market place. In this paper, I provide a brief overview of some of the existing approaches to defining and measuring equilibrium real rates and introduce a novel method based on yields on the U.S. Treasury’s inflation-indexed securities (TIIS). I discuss a simple framework for analyzing TIIS yields and illustrate how to use them to gauge the stance of monetary policy and overall economic prospects.

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This paper argues that a simple general equilibrium model can explain two of the most persistent term structure puzzles. First, Donaldson, Johnsen, and Mehra (1990) show that while in the U.S. nominal term structure the interest rates are pro-cyclical and term spreads counter-cyclical the stochastic growth model predicts that the interest rates are counter-cyclical and term spreads pro-cyclical. The resolution of this puzzle is simple. Using the data on the U.K. index-linked bonds, I show that during the sample period 1984:1{1995:8 the (ex-ante) real interest rates were counter-cyclical and term spreads pro-cyclical. Second, according to Backus, Gregory, and Zin (1989) a complete markets model can account for neither the sign nor the magnitude of average risk premiums in forward prices. This paper applies recent research by Alvarez and Jermann (1999ab) to the term premium puzzle. It is shown that the model A previous version of this paper was circulated under the title \The Term Structure of Interest Rates under Limited Commitment. " Current version is preliminary and incomplete. Comments are most welcome. Revisions can be downloaded from

This paper discusses the use of parametric models for the term structure of interest rates and their uses. The paper focuses on a potential problem which arises out of the use of certain models. In most cases the process of parameter estimation involves the minimization or maximization of a function (for example, least squares or maximum likelihood). In some cases this function can have a global minimum/maximum plus one or more local minima/maxima. As we progress through time this leads to a process under which parameter estimates and the fitted term structure can jump about in a way which is inconsistent with bond-price changes. Here a number of models are identified as susceptible to this sort of problem. A new descriptive model (the restricted-exponential model) is proposed under which it is proved that the likelihood and Bayesian posterior functions have unique maxima: both in a zerocoupon bond market and in a low-coupon bond market. A counterexample shows that this result can brea...

The focus of this paper is on the use of the yield curve in monetary policy making. Theoretical arguments and a multi-country empirical analysis with an explicit focus on the euro area suggest the need for caution in case the Eurosystem uses the yield curve as an information variable for monetary policy, because multiple theoretical explanations exist for an observed movement in the yield curve, suggesting that policy reactions cannot be prescribed unambiguously. In addition, the empirical analysis shows that, in contrast with earlier findings of, for example, Hardouvelis (1994) and Bernard and Gerlach (1996), the information content of the yield curve is fairly limited. For the individual European countries participating in the Eurosystem as well as for the euro area as a whole, the yield spread possesses only very limited information relating to future movements in the inflation rate and output growth, over-and-above the information contained in the history of the latter variables. ECB Working Paper No 11 February 2000 4 I

This paper investigates the pricing of step-up bonds, ie, corporate bonds with provisions stating that the coupon payments increase as the credit rating level of the issuer declines. To assess the risk-neutral rating transition probabilities necessary to price these bonds, we introduce a new calibration method within the reduced-form rating-based model of Jarrow, Lando and Turnbull (1997). We also treat split ratings and adjust for rating outlook. Step-up bonds have been issued in large quantities in the European telecom sector, and we find that, through most of the sample, step-up bonds issued by the two largest issuers have traded at a discount relative to comparable fixed-coupon bonds from the same issuers. Our findings cannot be attributed to traditional liquidity factors, and they suggest that issuing step-up bonds increased the cost of capital for the issuers.

The views in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Federal Reserve Bank of San Francisco or the

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The term structure of interest rates – the relationship between interest rates in the economy and the term to maturity – forms the basis for the valuation of all fixed income instruments. Modeled as a series of cashflows due at different points of time in the future, the underlying price of a fixed income security can be calculated as the net present value of the stream of cashflows. Each cashflow, in such a formulation, has to be discounted using the interest rate for the associated term to maturity. Arriving at the appropriate set of interest rates- the ‘term structure ’ or the ‘zero coupon yield curve ’ (ZCYC) – for the Indian debt market, is the objective of the present exercise. Empirical analysis of the term structure of interest rates has a long history in developed countries