A model of the euro-area yield curve with discrete policy rates

Jean-Paul Renne

Working papers from Banque de France

Abstract: This paper presents a no-arbitrage model of the yield curve that explicitly incorporates the central-bank policy rate. After having estimated the model using daily euro-area data, I explore the behaviour of risk premia at the short end of the yield curve. These risk premia are neglected by the widely-used practice that consists in backing out market forecasts of future policy-rate moves from money-market forward rates. The results suggest that this practice is valid in terms of sign of the expected target moves, but that it tends to overestimate their size. As an additional contribution, the model is exploited to simulate forward-guidance measures. A credible commitment of the central bank to keep its policy rate unchanged for a given period of time can result in substantial declines in yields. For instance, a central-bank commitment to keep the policy rate at 1% over the next 2 years would imply a decline in the 5-year rate of about 25 basis points.

Keywords: affine term-structure models; zero lower bound; regime switching; forward policy guidance. (search for similar items in EconPapers)
JEL-codes: E43 E44 E47 E52 G12 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2012
New Economics Papers: this item is included in nep-eec, nep-fmk, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Related works:
Journal Article: A model of the euro-area yield curve with discrete policy rates (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:395

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