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Forecasting the term structure of government bond yields
 Journal of Econometrics
, 2006
"... Despite powerful advances in yield curve modeling in the last twenty years, comparatively little attention has been paid to the key practical problem of forecasting the yield curve. In this paper we do so. We use neither the noarbitrage approach, which focuses on accurately fitting the cross sectio ..."
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Cited by 287 (16 self)
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Despite powerful advances in yield curve modeling in the last twenty years, comparatively little attention has been paid to the key practical problem of forecasting the yield curve. In this paper we do so. We use neither the noarbitrage approach, which focuses on accurately fitting the cross section of interest rates at any given time but neglects timeseries dynamics, nor the equilibrium approach, which focuses on timeseries dynamics (primarily those of the instantaneous rate) but pays comparatively little attention to fitting the entire cross section at any given time and has been shown to forecast poorly. Instead, we use variations on the NelsonSiegel exponential components framework to model the entire yield curve, periodbyperiod, as a threedimensional parameter evolving dynamically. We show that the three timevarying parameters may be interpreted as factors corresponding to level, slope and curvature, and that they may be estimated with high efficiency. We propose and estimate autoregressive models for the factors, and we show that our models are consistent with a variety of stylized facts regarding the yield curve. We use our models to produce termstructure forecasts at both short and long horizons, with encouraging results. In particular, our forecasts appear much more accurate at long horizons than various standard benchmark forecasts. Finally, we discuss a number of extensions, including generalized duration measures, applications to active bond portfolio management, and arbitragefree specifications. Acknowledgments: The National Science Foundation and the Wharton Financial Institutions Center provided research support. For helpful comments we are grateful to Dave Backus, Rob Bliss, Michael Brandt, Todd Clark, Qiang Dai, Ron Gallant, Mike Gibbons, Da...
What does the Yield Curve Tell us about GDP Growth?
, 2003
"... A lot, including a few things you may not expect. Previous studies find that the term spread forecasts GDP but these regressions are unconstrained and do not model regressor endogeneity. We build a dynamic model for GDP growth and yields that completely characterizes expectations of GDP. The model d ..."
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Cited by 193 (7 self)
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A lot, including a few things you may not expect. Previous studies find that the term spread forecasts GDP but these regressions are unconstrained and do not model regressor endogeneity. We build a dynamic model for GDP growth and yields that completely characterizes expectations of GDP. The model does not permit arbitrage. Contrary to previous findings, we predict that the short rate has more predictive power than any term spread. We confirm this finding by forecasting GDP outofsample. The model also recommends the use of lagged GDP and the longest maturity yield to measure slope. Greater efficiency enables the yieldcurve model to produce superior outofsample GDP forecasts than unconstrained OLS at all horizons.
The macroeconomy and the yield curve: a dynamic latent factor approach
 Journal of Econometrics
, 2006
"... Abstract: We estimate a model that summarizes the yield curve using latent factors (specifically, level, slope, and curvature) and also includes observable macroeconomic variables (specifically, real activity, inflation, and the monetary policy instrument). Our goal is to provide a characterization ..."
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Cited by 145 (15 self)
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Abstract: We estimate a model that summarizes the yield curve using latent factors (specifically, level, slope, and curvature) and also includes observable macroeconomic variables (specifically, real activity, inflation, and the monetary policy instrument). Our goal is to provide a characterization of the dynamic interactions between the macroeconomy and the yield curve. We find strong evidence of the effects of macro variables on future movements in the yield curve and evidence for a reverse influence as well. We also relate our results to the expectations hypothesis.
A ConsumptionBased Model of the Term Structure of Interest Rates
, 2004
"... This paper proposes a consumptionbased model that can account for many features of the nominal term structure of interest rates. The driving force behind the model is a timevarying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expec ..."
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Cited by 143 (9 self)
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This paper proposes a consumptionbased model that can account for many features of the nominal term structure of interest rates. The driving force behind the model is a timevarying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expected inflation. When calibrated to data on consumption, inflation, and the average level of bond yields, the model produces realistic volatility of bond yields and can explain key aspects of the expectations puzzle documented by Campbell and Shiller (1991) and Fama and Bliss (1987). When actual consumption and inflation data are fed into the model, the model is shown to account for many of the short and longrun fluctuations in the shortterm interest rate and the yield spread. At the same time, the model captures the high equity premium and
Decomposing the Yield Curve
, 2006
"... We construct an affine model that incorporates bond risk premia. By understanding risk premia, we are able to use a lot of information from wellmeasured riskneutral dyanmics to characterize real expectations. We use the model to decompose the yield curve into expected interest rate and risk premiu ..."
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Cited by 117 (12 self)
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We construct an affine model that incorporates bond risk premia. By understanding risk premia, we are able to use a lot of information from wellmeasured riskneutral dyanmics to characterize real expectations. We use the model to decompose the yield curve into expected interest rate and risk premium components. We characterize the interesting term structure of risk premia — a forward rate reflects expected excess returns many years into the future, and current slope and curvature factors forecast future expected returns even though they do not forecast current returns.
The Term Structure of Real Rates and Expected Inflation
, 2004
"... Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, timevarying prices of risk, and inflation to identify these components of the nominal yield curve. We ..."
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Cited by 114 (17 self)
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Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, timevarying prices of risk, and inflation to identify these components of the nominal yield curve. We find that the unconditional real rate curve is fairly flat at 1.44%, but slightly humped. In one regime, the real term structure is steeply downward sloping. Real rates (nominal rates) are procyclical (countercyclical) and inflation is negatively correlated with real rates. An inflation risk premium that increases with the horizon fully accounts for the generally upward sloping nominal term structure. We find that expected inflation drives about 80 % of the variation of nominal yields at both short and long maturities, but during normal times, all of the
A Joint Econometric Model of Macroeconomic and Term Structure Dynamics
 Journal of Econometrics
, 2006
"... In 2004 all publications will carry a motif taken from the €100 banknote. This paper can be downloaded without charge from ..."
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Cited by 111 (3 self)
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In 2004 all publications will carry a motif taken from the €100 banknote. This paper can be downloaded without charge from
Why is longhorizon equity less risky? A durationbased explanation of the value premium, NBER working paper
, 2005
"... We propose a dynamic riskbased model that captures the value premium. Firms are modeled as longlived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model im ..."
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Cited by 105 (21 self)
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We propose a dynamic riskbased model that captures the value premium. Firms are modeled as longlived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model implies that growth firms covary more with the discount rate than do value firms, which covary more with cash flows. When calibrated to explain aggregate stock market behavior, the model accounts for the observed value premium, the high Sharpe ratios on value firms, and the poor performance of the CAPM. THIS PAPER PROPOSES A DYNAMIC RISKBASED MODEL that captures both the high expected returns on value stocks relative to growth stocks, and the failure of the capital asset pricing model to explain these expected returns. The value premium, first noted by Graham and Dodd (1934), is the finding that assets with a high ratio of price to fundamentals (growth stocks) have low expected returns relative to assets with a low ratio of price to fundamentals (value stocks). This