The US Economy, the Treasury Bond Market and the Specification of Macro-Finance Models

Peter Spencer

Discussion Papers from Department of Economics, University of York

Abstract: This paper addresses questions about the structure of the economy and financial markets raised by recent research on the term structure. The work of Duffee (2012) and Joslin, Preibsch and Singleton (2012) suggests that macroeconomic variables affect risk premia rather than bond yields, which are driven by just three factors as in the traditional model. This is consistent with the observation that the real world macro-dynamics appear to be much richer than the risk neutral dynamics underpinning the term structure. On the other hand, Cochrane and Piazzesi (2005) and (2010) suggest that premia are much simpler, depending upon a single return forecasting factor but not macro variables. This paper suggests that the traditional model is too restrictive, performing poorly at the long end. A model with two return-forecasting factors works remarkably well.

Keywords: Macro-finance; Kalman augmented VAR; term structure; interest rate expectations; risk premia (search for similar items in EconPapers)
JEL-codes: C13 C58 E43 E44 E52 G12 (search for similar items in EconPapers)
Date: 2013-08
New Economics Papers: this item is included in nep-fmk
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