Time-varying variance decomposition of macro-finance term structure models

Anne Lundgaard Hansen

Journal of Empirical Finance, 2024, vol. 79, issue C

Abstract: This paper studies time-series patterns in the contribution of macroeconomic shocks to the variation in U.S. Treasury bond yields. I consider a term structure model with time-varying conditional volatility, which implies time variation in the decomposition of forecast error variances. Based on the model, I show that the macroeconomic contribution to the variation in short-term yields has increased since the 1970s. A similar pattern characterizes the variation in the expectations on future interest rates. This trend is not reflected in long-term yields because macroeconomic shocks drive negative correlations between short-rate expectations and term premia. Finally, I show that accounting for time-varying volatility is important even for estimating the average macroeconomic contribution to yield curve volatility over a fixed sample.

Keywords: Macro-finance term structure model; Bond market volatility; Multivariate GARCH (search for similar items in EconPapers)
JEL-codes: E43 E44 G12 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:79:y:2024:i:c:s0927539824000975

DOI: 10.1016/j.jempfin.2024.101563

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