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The Role of Monetary Policy Uncertainty in the Term Structure of Interest Rates

Junko Koeda and Ryo Kato ()

No 10-E-24, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: We examine the effect of uncertainty arising from policy-shock volatility on yield-curve dynamics. In contrast to the assumption of many macro-finance models, policy-shock processes appear to be time varying and persistent. We allow for this heteroskedasticity by constructing a no-arbitrage GARCH affine term structure model, in which policy-shock volatility is defined as the conditional volatility of the error term in a Taylor rule. We find that an increase in monetary policy uncertainty raises the medium- and longer-term spreads in a model that incorporates macroeconomic dynamics.

Keywords: GARCH; Estimation; Term Structure of Interest Rates; Financial Markets and the Macro-economy; Monetary Policy (search for similar items in EconPapers)
JEL-codes: C13 C32 E43 E44 E52 (search for similar items in EconPapers)
Date: 2010-10
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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