COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1634 Estimating Term Structure Equations Using Macroeconomic Variables Ray C. Fair January 2008 This paper begins with the expectations theory of the term structure of interest rates
with constant term premia and then postulates how expectations of future short term
interest rates are formed. Expectations depend in part on predictions from a set of VAR
equations and in part on the current and two lagged values of the short term interest
rate. The results suggest that there is relevant independent information in both the VAR
equations' predictions and the current and two lagged values of the short rate. The model
fits the long term interest rate data well, including the 2004-2006 period, which some
have found a puzzle. The properties of the model are consistent with the response of the
long term U.S. Treasury bond rate to surprise price and employment announcements. The
overall results suggest that long term rates can be fairly well explained by modeling
expectation formation of future short term rates. |
