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Macroeconomic shocks and evolution of term structure of interest rate: A dynamic latent factor approach

Sanjay Singh () and Neeraj Hatekar ()
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Sanjay Singh: Reserve Bank of India
Neeraj Hatekar: University of Mumbai

Indian Economic Review, 2018, vol. 53, issue 1, 245-262

Abstract: Abstract It is imperative to assess the impact of macroeconomic shocks on the health of financial institutions under macro-prudential surveillance, which percolate through interest rate risk, because any change in the interest rate term structure would affect their profit and loss account through income from interest earning assets and expenses on interest bearing liabilities. Accordingly, this paper empirically evaluates impact of key macroeconomic variables, namely, output gap, inflation and policy rate on the term structure of the Indian G-sec using latent factor model. First, level, slope and curvature of the yield curve were modelled dynamically through dynamic latent factor model and then these factors were linked to the macroeconomic variables using vector autoregressive framework. The empirical findings show a strong evidence of the effects of macroeconomic shocks on future movements in the yield curve.

Keywords: Term structure; Yield curve; Macroeconomic fundamentals; Latent factor model; State-space model (search for similar items in EconPapers)
JEL-codes: C3 E3 G1 (search for similar items in EconPapers)
Date: 2018
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