Working Paper: CEPR ID: DP5341
Authors: Don H. Kim; Athanasios Orphanides
Abstract: The estimation of dynamic no-arbitrage term structure models with a flexible specification of the market price of risk is beset by a severe small-sample problem arising from the highly persistent nature of interest rates. We propose using survey forecasts of a short-term interest rate as an additional input to the estimation to overcome the problem. The three-factor pure-Gaussian model thus estimated with the U.S. Treasury term structure for the 1990-2003 period generates a stable estimate of the expected path of the short rate, reproduces the well-known stylized patterns in the expectations hypothesis tests, and captures some of the short-run variations in the survey forecast of the changes in longer-term interest rates.
Keywords: dynamic term structure models; expectations hypothesis; interest rate forecasts; survey data; term premia
JEL Codes: E43; E47; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| survey forecasts (G17) | stability and precision of parameter estimates (C51) |
| survey forecasts (G17) | reduction in bias and imprecision (C83) |
| survey data (C83) | more reasonable forecasts of long-term interest rates (E47) |
| survey data (C83) | effective proxies for rational expectations (D84) |