Expectations, risk premia and information spanning in dynamic term structure model estimation

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 28 March 2014

Working Paper No. 489
By Rodrigo Guimarães

This article examines the nature of the empirical instability in dynamic term structure models. I show that using survey forecasts is an effective solution because it directly addresses the information imbalance at the heart of the instability: it increases the (cross-section) information on actual dynamics, bridging the gap with the large (cross-section) information on the risk-adjusted dynamics. I relate this to other information spanning problems, particularly spanning of macro factors, and discuss the desirability of anchoring models to surveys. I also show that restricting prices of risk is not effective in ensuring stable and sensible implied expectations.

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