Working Paper: CEPR ID: DP18590
Authors: Carlo A. Favero; Ruben Fernandez-Fuertes
Abstract: This paper proposes an Affine Macro Term Structure model in which yields are drifting, sharing a common stochastic trend driven by the drift in short-term (monetary policy) rates and excess returns are stationary as the compensation for risk is driven by the cycles in yields. We apply the approach to US data and compare the empirical results from the new specification with those obtained from standard Affine Term Structure models. The cycle-trend decomposition-based Affine Term Structure model produces much better forecasts of the dynamics of yields and, consequently, different and stationary dynamics for the term premia.
Keywords: Affine term structure models; Trends and cycles; Term premia
JEL Codes: E43; E52; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| short-term monetary policy rates (E52) | yields (G12) |
| yields (G12) | excess returns (D46) |
| natural rate of interest and inflation expectations (E43) | yields (G12) |
| yields (G12) | cycles in yields (E32) |
| cycles in yields (E32) | excess returns (D46) |
| cycle-trend decomposition model (C22) | dynamics of yields (E43) |
| cycle-trend decomposition model (C22) | stationary dynamics for term premia (E43) |