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Risk Premiums in Dynamic Term Structure Models with . . .
, 2010
"... This paper quantifies how variation in real economic activity and inflation in the U.S. influenced the market prices of level, slope, and curvature risks in U.S. Treasury markets. To accomplish this we develop a novel arbitragefree DT SM in which macroeconomic risks – in particular, real output and ..."
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Cited by 66 (10 self)
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This paper quantifies how variation in real economic activity and inflation in the U.S. influenced the market prices of level, slope, and curvature risks in U.S. Treasury markets. To accomplish this we develop a novel arbitragefree DT SM in which macroeconomic risks – in particular, real output and inflation risks – impact bond investment decisions separately from information about the shape of the yield curve. Estimates of our preferred macroDT SM over the twentythree year period from 1985 through 2007 reveal that unspanned macro risks explained a substantial proportion of the variation in forward terms premiums. Unspanned macro risks accounted for nearly 90 % of the conditional variation in shortdated forward term premiums, with unspanned real economic growth being the key driving factor. Over horizons beyond three years, these effects were entirely attributable to unspanned inflation. Using our model, we also reassess some of Chairman Bernanke’s remarks on the interplay between term premiums, the shape of the yield curve, and macroeconomic activity.
Why Gaussian MacroFinance Term Structure Models are (Nearly) Unconstrained FactorVARs.” Discussion paper,
, 2011
"... ABSTRACT This article develops a new family of Gaussian macrodynamic term structure models (MTSMs) in which bond yields follow a lowdimensional factor structure and the historical distribution of bond yields and macroeconomic variables is characterized by a vectorautoregression with order p > 1 ..."
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Cited by 21 (7 self)
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ABSTRACT This article develops a new family of Gaussian macrodynamic term structure models (MTSMs) in which bond yields follow a lowdimensional factor structure and the historical distribution of bond yields and macroeconomic variables is characterized by a vectorautoregression with order p > 1. Most formulations of MTSMs with p > 1 are shown to imply a much higher dimensional factor structure for yields than what is called for by historical data. In contrast, our "asymmetric" arbitragefree MTSM gives modelers the flexibility to match historical lag distributions with p > 1 while maintaining a parsimonious factor representation of yields. Using our canonical family of MTSMs we revisit: (i) the impact of noarbitrage restrictions on the joint distribution of bond yields and macro risks, comparing models with and without the restriction that macro risks are spanned by yieldcurve information; and (ii) the identification of the policy parameters in Taylorstyle monetary policy rules within MTSMs with macro risk factors and lags. ( JEL: G12,E43, C58, E58) KEYWORDS: Macrofinance term structure model, Lags, Taylor Rule Identification Dynamic term structure models in which a subset of the pricing factors are macroeconomic variables (MTSMs) often have bond yields depending on lags of these factors. 1 As typically parameterized, such MTSMs imply that the crosssection
Affine Diffusion Processes: Theory and Applications
 In Advanced Financial Modelling
, 2009
"... We revisit affine diffusion processes on general and on the canonical state space in particular. A detailed study of theoretic and applied aspects of this class of Markov processes is given. In particular, we derive admissibility conditions and provide a full proof of existence and uniqueness throug ..."
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Cited by 18 (6 self)
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We revisit affine diffusion processes on general and on the canonical state space in particular. A detailed study of theoretic and applied aspects of this class of Markov processes is given. In particular, we derive admissibility conditions and provide a full proof of existence and uniqueness through stochastic invariance of the canonical state space. Existence of exponential moments and the full range of validity of the affine transform formula are established. This is applied to the pricing of bond and stock options, which is illustrated for the Vasiček, Cox–Ingersoll–Ross and Heston models. 1
Pricing and hedging volatility risk in fixed income markets, Working Paper
, 2008
"... ∗I am very grateful to my advisor Ken Singleton for numerous discussions and comments. I also appreciate comments provided by my dissertation committe, Darrell Duffie ..."
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Cited by 9 (1 self)
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∗I am very grateful to my advisor Ken Singleton for numerous discussions and comments. I also appreciate comments provided by my dissertation committe, Darrell Duffie
The Structure of Risks in Equilibrium Affine Models of Bond Yields ∗
, 2013
"... Many equilibrium term structure models (ETSMs) in which the state of the economy follows an affine process imply that the variation in expected excess returns on bond portfolio positions is fully spanned by the conditional variances of the state variables. We show that these two assumptions alone – ..."
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Cited by 6 (4 self)
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Many equilibrium term structure models (ETSMs) in which the state of the economy follows an affine process imply that the variation in expected excess returns on bond portfolio positions is fully spanned by the conditional variances of the state variables. We show that these two assumptions alone – an affine state process with conditional variances that span expected excess returns – are sufficient to econometrically identify the factors determining risk premiums in these ETSMs from data on the term structure of bond yields. Using this result we derive maximum likelihood estimates of the conditional variances of the state – the “quantities of risk” – and evaluate the goodnessoffit of a large family of affine ETSMs. These assessments of fit are fully robust to the values of the parameters governing preferences and the evolution of the state, and to whether or not the economy is arbitrage free. Our findings suggest that, to be consistent with U.S. macroeconomic and Treasury yield data, affine ETSMs should have the features that: (i) inflation risk, and not longrun risks or variation in risk premiums arising from habitbased preferences, is a significant (and perhaps the dominant) risk underlying risk premiums in U.S. Treasury markets; and (ii) risks that are unspanned by bond yields have substantial explanatory power for risk premiums consistent with timevarying market prices of risks.
An Equilibrium Term Structure Model with Recursive Preferences
"... Equilibrium, affine asset pricing models with ..."
LinearRational Term Structure Models
, 2014
"... The current environment with very low interest rates creates difficulties for many existing term structure models, most notably Gaussian or conditionally Gaussian models that invariably place large probabilities on negative future interest rates. Models that respect the zero lower bound (ZLB) on in ..."
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The current environment with very low interest rates creates difficulties for many existing term structure models, most notably Gaussian or conditionally Gaussian models that invariably place large probabilities on negative future interest rates. Models that respect the zero lower bound (ZLB) on interest rates exist but are often restricted in terms of accommodat
A Robust Analysis of the RiskStructure of Equilibrium Term Structures of Bond Yields
, 2012
"... Many equilibrium term structure models (ET SMs) in which the state of the economy zt follows an affine process imply that the variation in expected excess returns on bond portfolio positions is fully spanned by the set of conditional variances ς2 t of zt. We show that these two assumptions alone – s ..."
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Many equilibrium term structure models (ET SMs) in which the state of the economy zt follows an affine process imply that the variation in expected excess returns on bond portfolio positions is fully spanned by the set of conditional variances ς2 t of zt. We show that these two assumptions alone – spanning of expected excess returns by the variances of affine processes zt – are sufficient to econometrically identify the quantities of risk ς2 t that span risk premiums from the term structure of bond yields. Using this result we derive maximum likelihood estimates of ς2 t and evaluate the goodnessoffit of the family of affine ET SMs that imply this tight link between premiums and quantities of risk. These assessments are fully robust to the values of the parameters governing preferences and the evolution of the state zt, and to whether or not the economy is arbitrage free. Our findings suggest that, to be consistent with U.S. macroeconomic and Treasury yield data, affine ET SMs should have the features that: (i) the fundamental sources of risks, including consumption growth, inflation, and yield volatilities are driven by distinct economic shocks; (ii) consumption growth risk alone does not fully account for the predictability of excess returns on bonds; and (iii) inflation risk, and not longrun risks or variation in risk premiums arising from habitbased preferences, is a significant (and perhaps the dominant) risk underlying risk premiums in U.S. Treasury markets.