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What was the market's view of U.K. monetary policy? Estimating inflation risk and expected inflation with indexed bonds
A measure of the credibility of monetary policy is the inflation risk premium in nominal yields. This will be time varying and can be estimated by combining the information in the nominal term structure with that in the real term structure. We estimate these risk premia using a generalized CIR affine-yield model, with one factor driving the real term structure of monthly observations on two-year, five-year and ten-year UK index-linked debt and two factors driving the term structure of the corresponding nominal yields. Our estimates show that the inflation risk premium contributes on average ...
Report
A three-factor econometric model of the U.S. term structure
We estimate and test a model of the U.S. term structure that fits both the time series of interest rates and the cross-sectional shapes of the yield and volatility curves. In the model, three unobserved factors drive a stochastic discount process that prices assets so as to rule out arbitrage opportunities. The resulting bond yields are conveniently affine in the factors. We use monthly zero-coupon yield data from January 1986 to March 1996 and estimate the model by applying a Kalman filter that takes into account the model's no-arbitrage restrictions and using only three maturities at a ...
Report
Two factors along the yield curve
We estimate two-factor equilibrium models on different parts of the yield curve. In this exploration of the term structure of interest rates, we use two-factor affine yield models as our diagnostic tool. The exercise provides insights on how to reconcile the time-series dynamics of interest rates with the cross-sectional shapes of the term structure and on how movements in the yield curve are related to macroeconomic fundamentals. The evidence favors models in which one factor reverts over time to a time-varying mean. One such model seems adequate to explain three-month to two-year bond ...
Report
A three-factor econometric model of the U.S. term structure
We estimate a three-factor model to fit both the time-series dynamics and cross-sectional shapes of the U.S. term structure. In the model, three unobserved factors drive a discrete-time stochastic discount process, with one factor reverting to a fixed mean and a second factor reverting to a third factor. To exploit the conditional density of yields, we estimate the model with a Kalman filter, a procedure that also allows us to use data for six maturities without making special assumptions about measurement errors. The estimated model reproduces the basic shapes of the average term structure, ...
Report
Inflation risk in the U.S. yield curve: the usefulness of indexed bonds
The inflation-indexed bonds the U.S. Treasury plans to issue will reduce the expected borrowing cost if the yield curve reflects a risk premium for inflation. In the United Kingdom, indexed bonds are also used to extract inflationary expectations and thus to guide monetary policy. The bonds will produce a more reliable measure of such expectations if the inflation risk premium is taken into account. We estimate such a risk premium for the United States by means of a two-factor affine-yield model of the term structure. The model allows both the inflation risk premium and real term premium to ...