Modelling the Term Structure with Trends in Yields and Cycles in Excess Returns

Carlo A. Favero and Ruben Fernandez-Fuertes

No 23210, BAFFI CAREFIN Working Papers from BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy

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 decompositionbased 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 (search for similar items in EconPapers)
JEL-codes: E43 E52 G12 (search for similar items in EconPapers)
Pages: 39
Date: 2023
New Economics Papers: this item is included in nep-ets and nep-mon
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