The Canadian macroeconomy and the yield curve: an equilibrium-based approach

René Garcia and Richard Luger

Canadian Journal of Economics, 2007, vol. 40, issue 2, 561-583

Abstract: The authors develop and estimate an equilibrium-based model of the Canadian term structure of interest rates. The proposed model incorporates a vector-autoregression description of key macroeconomic dynamics and links them to those of the term structure, where identifying restrictions are based on the first-order conditions that describe the representative investor's optimal consumption and portfolio plan. A remarkable result is that the in-sample average pricing errors obtained with the equilibrium-based model are only slightly larger than those obtained with a far more flexible no-arbitrage model. The gains associated with parsimony become obvious out-of-sample, where the equilibrium model delivers much more accurate predictions, especially for yields with longer-term maturities. The preferred equilibrium model has impulse responses that are consistent with long-term inflation expectations being anchored, so a surprise increase in inflation does not necessarily raise expectations of higher future inflation.

JEL-codes: E43 E44 E47 E52 (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (8)

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Related works:
Journal Article: The Canadian macroeconomy and the yield curve: an equilibrium‐based approach (2007)
Working Paper: The Canadian Macroeconomy and the Yield Curve: An Equilibrium-Based Approach (2005)
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