Modelling the Term Structure with Trends in Yields and Cycles in Excess Returns

Carlo A. Favero and Ruben Fernandez-Fuertes

No 18590, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper proposes an Affine Macro Term Structure model in which yields are drifting, sharing a common stochastic trend driven by the drift in short-term (monetary policy) rates and excess returns are stationary as the compensation for risk is driven by the cycles in yields. We apply the approach to US data and compare the empirical results from the new specification with those obtained from standard Affine Term Structure models. The cycle-trend decomposition-based Affine Term Structure model produces much better forecasts of the dynamics of yields and, consequently, different and stationary dynamics for the term premia.

JEL-codes: E43 E52 G12 (search for similar items in EconPapers)
Date: 2023-11
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