Macro factors and the affine term structure of interest rates

This dissertation examines the relationship between the term structure of interest rates and the macro economy. In the first chapter an affine term structure model of bond yields is constructed from a underlying general equilibrium business-cycle model, with observable macro state variables of the structural economy as the factors. The factor representing monetary policy is strongly mean-reverting, and its influence on the term structure is primarily through changing the slope of the yield curve. The factor representing technology is more persistent, and it affects the term structure by shifting the level of the yield curve. The dynamic implications of the model for the macro economy and the term structure are consistent with the broad empirical patterns. From simulation studies of the macro-factor model I can extract the “level” and “slope” factors, similar to the ones extracted from the empirical term structure estimations. Simulation studies also show that the movement of the “slope” factor is primarily driven by the monetary-policy innovations, and the changes of the “level” factor is more closely associated with the aggregate-supply shocks from the private sector.; The second chapter examines the empirical relationship between the movement of the slope factor in term structure of nominal interest rates and exogenous monetary-policy shocks in the U.S. after 1982. Using first a six-variable VAR model and then a GMM estimation model of the “Taylor rule”, I estimate the exogenous monetary-policy shocks implied by each of them in the U.S. during this period. Meanwhile, a two-factor model is used to extract the underlying slope factor of the term structure. Results from the correlation study suggest that there is strong correlation between the slope factor and the exogenous monetary-policy shocks. Moreover, monetary-policy shocks can explain a large part of variability of the slope factor. This chapter provides strong evidence in support of Knez, Litterman and Scheinkman (1994)'s conjecture on the relation between the slope factor and the Federal Reserve policy, and is also consistent with the results of the general-equilibrium based simulation study in the first chapter.