Shifting endpoints in the term structure of interest rates

This paper links the term structure to perceptions of monetary policy. Long-horizon forecasts of short rates required by no-arbitrage term structure models are heavily influenced by the endpoints, or limiting conditional forecasts, of the short rate process. Common assumptions that the short rate is...

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Bibliographic Details
Published in:Journal of monetary economics 2001-06, Vol.47 (3), p.613-652
Main Authors: Kozicki, Sharon, Tinsley, P.A.
Format: Article
Language:English
Subjects:
Breakpoints
Changepoints
Convergence
Economic theory
Expectations
Expectations hypothesis
Interest rates
Learning
Monetary economics
Monetary policy
Statistics
Stochastic models
Studies
Term structure
Utility theory
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Summary:This paper links the term structure to perceptions of monetary policy. Long-horizon forecasts of short rates required by no-arbitrage term structure models are heavily influenced by the endpoints, or limiting conditional forecasts, of the short rate process. Common assumptions that the short rate is mean-reverting or contains a unit root are shown to generate unrealistic yield predictions. Failures occur because these assumptions inadequately account for historical shifts in market perceptions of the policy target for inflation. This paper links endpoint shifts to agent learning about shifts in long-term policy goals. Shifting endpoints in short rate processes significantly improve yield predictions.
ISSN:0304-3932
1873-1295
DOI:10.1016/S0304-3932(01)00054-X