Theory and empirics of an affine term structure model applied to European data

Vicente Jakas

MPRA Paper from University Library of Munich, Germany

Abstract: The basic asset pricing equation is adapted to include the effects of unemployment, consumers’ expectations, the price level and money supply on money market rates and government bond yields. Expected consumption growth is modelled using European unemployment figures and Eurostat Consumer Confidence Index. The price level is incorporated in the aggregate marginal utility function using production price index (PPI) as a proxy. An affine term structure model is derived using a state space system with an observation equation which links observable yields to these macroeconomic variables and a state equation which describes the dynamics of these variables. Unemployment and consumer confidence index will have a shift and a slope effect on the yield curve, for front-end yields moving faster than in the long end. Production price index exhibits a twist effect (flattening or steepening of the curve) which results in front-end yields shifting in opposite directions to the long end of the curve. This empirical work shows that yields are negatively correlated to money supply, as expected in classical IS-LM models. And that money supply exhibits a slope effect, with the front-end of the curve shifting faster than the longer end.

Keywords: Macroeconomic releases; Term structure of interest rates; Dynamic factors; Affine term structure models (search for similar items in EconPapers)
JEL-codes: E12 E43 E44 E52 G12 (search for similar items in EconPapers)
Date: 2011-07
New Economics Papers: this item is included in nep-mac and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Published in Aestimatio. The IEB International Journal of Finance 2 (2011): pp. 1-18

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