Michael Bauer


Financial Research

Monetary economics, Asset pricing, Econometrics

Michael.Bauer (at) sf.frb.org


Michael Bauer, Economist, Federal Reserve Bank San Francisco

Show less Current Unpublished Working Papers

Resolving the Spanning Puzzle in Macro-Finance Term Structure Models
2015-01 | With Rudebusch | January 2015

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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 | May 2015

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We show that conventional dynamic term structure models (DTSMs) estimated on recent U.S. data severely violate the zero lower bound (ZLB) on nominal interest rates and deliver poor forecasts of future short rates. In contrast, shadow-rate DTSMs account for the ZLB by construction, capture the resulting distributional asymmetry of future short rates, and achieve good forecast performance. These models provide more accurate estimates of the most likely path for future monetary policy—including the timing of policy liftoff from the ZLB and the pace of subsequent policy tightening. We also demonstrate the benefits of including macroeconomic factors in a shadow-rate DTSM when yields are constrained near the ZLB.

Restrictions on Risk Prices in Dynamic Term Structure Models
2011-03 | May 2015

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Restrictions on the risk-pricing in dynamic term structure models (DTSMs) can unleash the power of no-arbitrage by creating a tighter link between cross-sectional and time-series variation of interest rates. This paper presents a new econometric framework for estimation of affine Gaussian DTSMs under restrictions on risk prices, which addresses the issues of a large model space and of model uncertainty using a Bayesian approach. A simulation study demonstrates the good performance of the proposed method. I obtain novel results for the U.S. Treasury yield curve. The data strongly favor tight restrictions on risk pricing: only level risk is priced, and only changes in the slope affect term premia. Incorporating the favored restrictions into an otherwise standard model substantially alters implied short-rate expectations and term premia. Interest rate persistence is higher than in a maximally-flexible model, hence expectations of future short rates are more variable—restrictions on risk prices help resolve the puzzle of implausibly stable short-rate expectations in this literature. Restricted models attribute a larger share of the secular decline in long-term interest rates over the last twenty years to the expectations component, consistent with survey evidence on expectations of future interest rates and inflation.

Show less Published Articles (Refereed Journals and Volumes)

Nominal Interest Rates and the News
Journal of Money, Credit and Banking 47 (2-3), 2015, 295-331

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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.

Inflation Expectations and the News
International Journal of Central Banking 11 (2), 2015, 1-40

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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.

The Signaling Channel for Federal Reserve Bond Purchases
International Journal of Central Banking 10(3), September 2014, 233-289 | With Rudebusch

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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

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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

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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

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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.

Show less FRBSF Publications

Optimal Policy and Market-Based Expectations
Economic Letter 2015-12 | April 13, 2015 | With Rudebusch

Options-Based Expecations of Future Policy Rates
Economic Letter 2014-29 | September 29, 2014

Financial Market Outlook for Inflation
Economic Letter 2014-14 | May 12, 2014 | With Christensen

Expectations for Monetary Policy Liftoff
Economic Letter 2013-34 | November 18, 2013 | With Rudebusch

What Caused the Decline in Long-term Yields?
Economic Letter 2013-19 | July 8, 2013 | With Rudebusch

Monetary Policy and Interest Rate Uncertainty
Economic Letter 2012-38 | December 24, 2012

Fed Asset Buying and Private Borrowing Rates
Economic Letter 2012-16 | May 21, 2012

Signals from Unconventional Monetary Policy
Economic Letter 2011-36 | November 21, 2011 | With Rudebusch

What Moves the Interest Rate Term Structure?
Economic Letter 2011-34 | November 7, 2011

Show more Other Works

Testing for Endogenous Growth
In Master’s Thesis | Germany: VDM Publishing, 2004

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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.