Resolving the Spanning Puzzle in Macro-Finance Term Structure Models

Authors

Glenn D. Rudebusch

Download PDF
(495 KB)

2015-01 | May 1, 2016

Most existing macro-finance term structure models (MTSMs) appear incompatible with regression evidence of unspanned macro risk. This “spanning puzzle” appears to invalidate those models in favor of new unspanned MTSMs. However, our empirical analysis supports the previous spanned models. Using simulations to investigate the spanning implications of MTSMs, we show that a canonical spanned model is consistent with the regression evidence; thus, we resolve the spanning puzzle. In addition, direct likelihood-ratio tests find that the knife-edge restrictions of unspanned models are rejected with high statistical significance, though these restrictions have only small effects on cross-sectional fit and estimated term premia.

Article Citation

Rudebusch, Glenn D., and Michael Bauer. 2015. “Resolving the Spanning Puzzle in Macro-Finance Term Structure Models,” Federal Reserve Bank of San Francisco Working Paper 2015-01. Available at https://doi.org/10.24148/wp2015-01

About the Author
Michael Bauer
Michael Bauer is a senior research advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco and research fellow at CEPR. Learn more about Michael Bauer