Long-run priors for term structure models

Andrew Meldrum and Matt Roberts-Sklar

No 575, Bank of England working papers from Bank of England

Abstract: Dynamic no-arbitrage term structure models are popular tools for decomposing bond yields into expectations of future short-term interest rates and term premia. But there is insufficient information in the time series of observed yields to estimate the unconditional mean of yields in maximally flexible models. This can result in implausibly low estimates of long-term expected future short-term interest rates, as well as considerable uncertainty around those estimates. This paper proposes a tractable Bayesian approach for incorporating prior information about the unconditional means of yields. We apply it to UK data and find that with reasonable priors it results in more plausible estimates of the long-run average of yields, lower estimates of term premia in long-term bonds and substantially reduced uncertainty around these decompositions in both affine and shadow rate term structure models.

Keywords: Affine term structure model; shadow rate term structure model; Gibbs sampler (search for similar items in EconPapers)
JEL-codes: C11 E43 G12 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2015-12-18
New Economics Papers: this item is included in nep-ecm, nep-mac and nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0575

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