A New-Keynesian Model of the Yield Curve with Learning Dynamics: A Bayesian Evaluation

40 Pages Posted: 2 Nov 2011

See all articles by Hans Dewachter

Hans Dewachter

Catholic University of Leuven (KUL) - Department of Economics; Erasmus Research Institute of Management (ERIM)

Leonardo Iania

Université catholique de Louvain; KU Leuven, Department Accounting, Finance and Insurance

Marco Lyrio

Insper Institute of Education and Research

Date Written: September 1, 2011

Abstract

We estimate a New-Keynesian macro-finance model of the yield curve incorporating learning by private agents with respect to the long-run expectation of inflation and the equilibrium real interest rate. A preliminary analysis shows that some liquidity premia, expressed as a degree of mispricing relative to no-arbitrage restrictions, and time variation in the prices of risk are important features of the data. These features are, therefore, included in our learning model. The model is estimated on U.S. data using Bayesian techniques. The learning model succeeds in explaining the yield curve movements in terms of macroeconomic shocks. The results also show that the introduction of a learning dynamics is not sufficient to explain the rejection of the extended expectations hypothesis. The learning mechanism, however, reveals some interesting points. We observe an important difference between the estimated inflation target of the central bank and the perceived long-run inflation expectation of private agents, implying the latter were weakly anchored. This is especially the case for the period from mid-1970s to mid-1990s. The learning model also allows a new interpretation of the standard level, slope, and curvature factors based on macroeconomic variables. In line with standard macro-finance models, the slope and curvature factors are mainly driven by exogenous monetary policy shocks. Most of the variation in the level factor, however, is due to shocks to the output-neutral real rate, in contrast to the mentioned literature which attributes most of its variation to long-run inflation expectations.

Keywords: New-Keynesian model, Affine yield curve model, Learning, Bayesian estimation

JEL Classification: E43, E44, E52

Suggested Citation

Dewachter, Hans and Iania, Leonardo and Lyrio, Marco, A New-Keynesian Model of the Yield Curve with Learning Dynamics: A Bayesian Evaluation (September 1, 2011). Available at SSRN: https://ssrn.com/abstract=1952928 or http://dx.doi.org/10.2139/ssrn.1952928

Hans Dewachter

Catholic University of Leuven (KUL) - Department of Economics ( email )

Center for Economic Studies
Naamsestraat 69
Leuven, B-3000
Belgium
+0032 16 326859 (Phone)
+0032 16 326796 (Fax)

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Leonardo Iania

Université catholique de Louvain ( email )

34, Voie du roman pays
louvain la neuve, 1348
Belgium

HOME PAGE: http://https://sites.google.com/site/ianialeonardo/

KU Leuven, Department Accounting, Finance and Insurance ( email )

Naamsestraat 69
Leuven, B-3000
Belgium

Marco Lyrio (Contact Author)

Insper Institute of Education and Research ( email )

R Quata 300
Sao Paulo, 04542-030
Brazil

HOME PAGE: http://www.insper.edu.br/en/faculty-and-research/marco-lyrio

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