Term structure modelling with observable state variables

Cristian Huse ()

Journal of Banking & Finance, 2011, vol. 35, issue 12, 3240-3252

Abstract: This paper proposes and implements a parsimonious three-factor model of the term structure whose dynamics is driven uniquely by observable state variables. This approach allows comparing alternative views on the way state variables – macroeconomic variables, in particular – influence the yield curve dynamics, avoids curse of dimensionality problems, and provides more reliable inference by using both the cross-sectional and the time series dimension of the data. I simulate the small-sample properties of the procedure and conduct in- and out-of-sample studies using a comprehensive set of US data. I show that even a parsimonious model where the level, slope and curvature factors of the term structure are driven by, respectively, inflation, monetary policy and economic activity consistently outperforms the (latent-variable) benchmark model in an out-of-sample study.

Keywords: Term structure; Interest rates; Yield curve estimation (search for similar items in EconPapers)
JEL-codes: C58 G12 G17 (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (15)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:35:y:2011:i:12:p:3240-3252

DOI: 10.1016/j.jbankfin.2011.05.004

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