The Predictive Power of the Yield Curve: A Theoretical Assessment
Posted: 30 Dec 2003
Abstract
Although the empirical evidence about the leading indicator property of the term spread (LIPTS) is powerful, this property lacks a rigorous theoretical foundation. This paper investigates whether dynamic equilibrium asset pricing models are able to provide a theoretical underpinning for the LIPTS. We study an endowment and a production economy. The endowment economy is unable to account for the LIPTS. On the other hand, a model with endogenous production provides a reasonable theoretical justification for the LIPTS.
Keywords: General equilibrium, leading indicators, term structure of interest rates, yield curve
JEL Classification: C68, E32, E43, E44
Suggested Citation: Suggested Citation