Current Unpublished Working Papers
Resolving the Spanning Puzzle in Macro-Finance Term Structure Models
2015-01 | With Rudebusch | January 2015
Previous macro-finance term structure models (MTSMs) imply that macroeconomic state variables are spanned by (i.e., perfectly correlated with) model-implied bond yields. However, this theoretical implication appears inconsistent with regressions showing that much macroeconomic variation is unspanned and that the unspanned variation helps forecast excess bond returns and future macroeconomic fluctuations. We resolve this contradiction—or “spanning puzzle”—by reconciling spanned MTSMs with the regression evidence, thus salvaging the previous macro-finance literature. Furthermore, we statistically reject “unspanned” MTSMs, which are an alternative resolution of the spanning puzzle, and show that their knife-edge restrictions are economically unimportant for determining term premia.
Monetary Policy Expectations at the Zero Lower Bound
2013-18 | With Rudebusch | February 2014
To obtain monetary policy expectations from the yield curve near the zero lower bound (ZLB), it is crucial to account for the distributional asymmetry of future short rates. Because conventional dynamic term structure models (DTSMs) ignore it, they severely violated the ZLB in recent years and performed significantly worse than alternative models that account for it. Shadow-rate models incorporate the ZLB, and therefore achieve superior fit and forecasting performance. In addition, they provide estimates of the modal short-rate path, which can serve to construct accurate and plausible forecasts of the time of future short-rate liftoff.
Bayesian Estimation of Dynamic Term Structure Models under Restrictions on Risk Pricing
2011-03 | April 2014
This paper performs Bayesian estimation of affine Gaussian dynamic term structure models (DTSMs) in which the risk-price parameters can be restricted. Using a new econometric framework for DTSM estimation, plausible restrictions are selected from a large set of possible candidates. Inference is carried out under these restrictions using Bayesian Model Averaging. A simulation study demonstrates the good performance of this approach, both for finding restrictions and for inference about the objects of interest. The empirical results using U.S. data show that tight restrictions on risk pricing are called for, with most risk-price parameters restricted to zero. Only level risk is priced, and it is mostly changes in the slope that affect the price of level risk. Interest rate persistence is significantly higher than in a maximally-flexible model, hence expectations of future short rates are more variable. The role for risk premia in explaining variability of longterm interest rates is diminished. The restricted models are able to capture the return predictability that is a salient feature of U.S. Treasury yields.
Published Articles (Refereed Journals and Volumes)
Inflation Expectations and the News
Forthcoming in International Journal of Central Banking
This paper provides new evidence on the importance of inflation expectations for variation in nominal interest rates, based on both market-based and survey-based measures of inflation expectations. Using the information in TIPS breakeven rates and inflation swap rates, I document that movements in inflation compensation are important for explaining variation in long-term nominal interest rates, both unconditionally as well as conditionally on macroeconomic data surprises. Daily changes in inflation compensation and changes in long-term nominal rates generally display a close statistical relationship. The sensitivity of inflation compensation to macroeconomic data surprises is substantial, and it explains a sizable share of the macro response of nominal rates. The paper also documents that survey expectations of inflation exhibit significant comovement with variation in nominal interest rates, as well as significant responses to macroeconomic news.
Nominal Interest Rates and the News
Forthcoming in Journal of Money, Credit and Banking
This paper provides new estimates of the impact of monetary policy actions and macroeconomic news on the term structure of nominal interest rates. The key novelty is to parsimoniously capture the impact of news on all interest rates using a simple no-arbitrage model. The different types of news are analyzed in a common framework by recognizing their heterogeneity, which allows for a systematic comparison of their effects. This approach leads to novel empirical findings: First, monetary policy causes a substantial amount of volatility in both short-term and long-term interest rates. Second, macroeconomic data surprises have small and mostly insignificant effects on the long end of the term structure. Third, the term-structure response to macroeconomic news is consistent with considerable interest-rate smoothing by the Federal Reserve. Fourth, monetary policy surprises are multidimensional while macroeconomic surprises are one-dimensional.
The Signaling Channel for Federal Reserve Bond Purchases
International Journal of Central Banking 10(3), September 2014, 233-289 | With Rudebusch
Previous research has emphasized the portfolio balance effects of Federal Reserve bond purchases, in which a reduced bond supply lowers term premia. In contrast, we find that such purchases have important signaling effects that lower expected future short-term interest rates. Our evidence comes from a model-free analysis and from dynamic term structure models
that decompose declines in yields following Federal Reserve announcements into changes in risk premia and expected short
rates. To overcome problems in measuring term premia, we consider bias-corrected model estimation and restricted risk price estimation. In comparison with other studies, our estimates of signaling effects are larger in magnitude and statistical significance.
International Channels of the Fed’s Unconventional Monetary Policy
Journal of International Money and Finance 44, June 2014, 24-46 | With Neely
Previous research has established that the Federal Reserve’s large scale asset purchases (LSAPs) significantly influenced international bond yields. We use dynamic term structure models to uncover to what extent signaling and portfolio balance channels caused these declines. For the U.S. and Canada, the evidence supports the view that LSAPs had substantial signaling effects. For Australian and German yields, signaling effects were present but likely more moderate, and portfolio balance effects appear to have played a relatively larger role than in the U.S. and Canada. Portfolio balance effects were small for Japanese yields and signaling effects basically nonexistent. These findings about LSAP channels are consistent with predictions based on interest rate dynamics during normal times: Signaling effects tend to be large for countries with strong yield responses to conventional U.S. monetary policy surprises, and portfolio balance effects are consistent with the degree of substitutability across international bonds, as measured by the covariance between foreign and U.S. bond returns.
Term Premia and Inflation Uncertainty: Empirical Evidence from an International Panel Dataset: Comment
American Economic Review 104(1), January 2014, 323-337 | With Rudebusch and Wu
Term premia implied by maximum likelihood estimates of affine term structure models are misleading because of small-sample bias. We show that accounting for this bias alters the conclusions about the trend, cycle, and macroeconomic determinants of the term premia estimated in Wright (2011). His term premium estimates are essentially acyclical, and often just parallel the secular trend in long-term interest rates. In contrast, bias-corrected term premia show pronounced countercyclical behavior, consistent with theoretical and empirical arguments about movements in risk premia.
Correcting Estimation Bias in Dynamic Term Structure Models
Journal of Business and Economic Statistics 30(3), July 2012, 454-467 | With Rudebusch and Wu
The affine dynamic term structure model (DTSM) is the canonical empirical finance representation of the yield curve. However, the possibility that DTSM estimates may be distorted by small-sample bias has been largely ignored. We show that conventional estimates of DTSM coefficients are indeed severely biased, and this bias results in misleading estimates of expected future short-term interest rates and of long-maturity term premia. We provide a variety of bias-corrected estimates of affine DTSMs, both for maximally-flexible and over-identified specifications. Our estimates imply short rate expectations and term premia that are more plausible from a macro-finance perspective.
Testing for Endogenous Growth
In Master’s Thesis | Germany: VDM Publishing, 2004
Models of endogenous growth have strong empirical predictions about the determinants of technological progress. This thesis details the implications of alternative R&D-based endogenous growth models, and then surveys the empirical literature that tests different aspects of this New Growth Theory. Numerous studies attempt to test the validity of endogenous growth models but come to very different conclusions, since varying hypotheses are considered. There are few rigorous and plausible empirical assessments of whether the determinants of technological progress conform to the predictions of the theory. I provide new evidence on the relevance of R&D intensity for economic growth, using dynamic panel data methods, thereby contributing to the empirical literature that finds support for R&D-based endogenous growth models.