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Interest Rates

Paper Session

Saturday, Jan. 6, 2018 8:00 AM - 10:00 AM

Loews Philadelphia, Commonwealth Hall A1
Hosted By: American Finance Association
  • Chair: Anna Cieslak, Duke University

Expectation and Duration at the Effective Lower Bound

Thomas King
,
Federal Reserve Bank of Chicago

Abstract

I study equilibrium bond pricing in a model with risk-averse arbitrageurs and an effective lower bound (ELB) on nominal rates. The model exposes nonlinear interactions among short-rate expectations, bond supply, and term premia that are absent from affine models, and these features help it replicate the observed behavior of the yield curve near the ELB, including event-study evidence on the effects of unconventional monetary policy. The pricing impact of both short-rate expectations and bond supply are attenuated at the ELB. However, under a calibration that matches the data, the model implies that shocks to the anticipated path of short-term interest rates were more important for long-term yields than shocks to investors' interest-rate risk exposures during the ELB period in the U.S..

Interest Rates Under Falling Stars

Michael Bauer
,
Federal Reserve Bank of San Francisco
Glenn Rudebusch
,
Federal Reserve Bank of San Francisco

Abstract

Theory predicts that the equilibrium real interest rate, r*, and the perceived trend in inflation, pi*, are key determinants of the term structure of interest rates. However, term structure analyses generally assume that these variables are constant. Instead, we show that allowing for time variation in both r* and pi* is crucial for understanding the empirical dynamics of U.S.~Treasury yields and risk pricing. Doing so fundamentally changes estimates of the risk and term premiums in long-term bond yields, substantially improves the accuracy of excess bond return forecasts and of long-range out-of-sample forecasts of interest rates, and captures a substantial share of interest rate variability at low frequencies.

A Time Series Model of Interest Rates With the Effective Lower Bound

Benjamin K. Johannsen
,
Federal Reserve Board
Elmar Mertens
,
Bank for International Settlements

Abstract

Modeling interest rates over samples that include the Great Recession requires taking stock of the effective lower bound (ELB) on nominal interest rates. We propose a flexible time--series approach which includes a ``shadow rate''---a notional rate that is less than the ELB during the period in which the bound is binding---without imposing no--arbitrage assumptions.
The shadow rate serves as a latent state variable to characterize the joint dynamics of yields and macro variables. The approach allows us to estimate the behavior of trend real rates as well as expected future interest rates in recent years.

Negative Interest Rate Policy and Yield Curve

Jing Cynthia Wu
,
University of Chicago
Fan Dora Xia
,
Bank for International Settlements

Abstract

We extract the market's expectations about the ECB's negative interest rate policy from the yield curve and study its impact on the yield curve. To capture the rich dynamics of the short end of the yield curve, we introduce two policy indicators, which summarize the immediate and longer-horizon future monetary policy stances. The ECB has cut interest rates four times under zero. We find the June 2014 and December 2015 cuts were expected the month before, and the September 2014 cut was unanticipated. Most interestingly, the March 2016 cut was expected 4 months before the actual cut.
Discussant(s)
Samuel Hanson
,
Harvard Business School
Greg Duffee
,
Johns Hopkins University
Leonardo Melosi
,
Federal Reserve Bank of Chicago
Don Kim
,
Federal Reserve Board
JEL Classifications
  • G1 - General Financial Markets