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A term structure model under cyclical fluctuations in interest rates

Manuel Moreno, Alfonso Novales () and Federico Platania

Economic Modelling, 2018, vol. 72, issue C, 140-150

Abstract: We propose a flexible yet tractable model of the term structure of interest rates (TSIR). Term structure models attempt to explain how interest rates depend on their maturities at a given point in time, characterizing the relationship between short-term and long-term rates. Our model can reproduce and fit a variety of TSIR shapes by capturing cyclical fluctuations of interest rates, different monetary policy reactions as witnessed pre- and post-crisis as well as the effect of the business cycle or exogenous shocks. Our modelling approach also provides a characterization of long-term fluctuations in the mean level of interest rates unveiling the effects of monetary policy interventions in interest rates. Furthermore, using daily US data, we compare the empirical ability of our model to both fit and forecast the TSIR under different economic scenarios. We show that our model improves pricing and risk management by fitting and predicting interest rates more accurately and precisely than do existing TSIR models.

Keywords: Term structure of interest rates; Cyclical fluctuations; Bond pricing; TSIR fitting performance; Interest rates forecast (search for similar items in EconPapers)
JEL-codes: D53 E43 G13 C58 E32 C31 (search for similar items in EconPapers)
Date: 2018
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