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Demographics and the behavior of interest rates
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Favero, Carlo A., Gozluklu, Arie E. and Yang, Haoxi (2016) Demographics and the behavior of interest rates. IMF Economic Review, 64 (4). pp. 732-776. doi:10.1057/s41308-016-0020-2 ISSN 2041-4161 .
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Official URL: http://doi.org/10.1057/s41308-016-0020-2
Abstract
Interest rates are very persistent. Modelling the persistent component of interest rates has important consequences for forecasting. Factor models of the term structure are restricted VAR models that project over a long-horizon the one-period risk free rate to obtain yields at longer horizon as the sum of the expected future monetary policy and the term premia. The included factors are typically mean reverting and the equilibrium real rates are considered constant (think, for example, of the standard Taylor-rule), partial adjustments to equilibrium yields are then used to rationalize the persistence in observed data. As a result the empirical models feature a very high level of persistence that makes long-horizon predictions inherently inaccurate. This paper relates the common persistent component of the U.S. term structure of interest rates to the age composition of population. The composition of age structure determines the equilibrium rate in the monetary policy rule and therefore the persistent component in one-period yields. Fluctuations in demographics are then transmitted to the whole term structure via the expected policy rate components. We build an a¢ ne term structure model (ATSM) which exploits demographic information to capture the dynamics of yields and produce useful forecasts of bond yields and excess returns that provides economic value for long-term investors.
Item Type: | Journal Article | ||||||
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Subjects: | H Social Sciences > HG Finance | ||||||
Divisions: | Faculty of Social Sciences > Warwick Business School | ||||||
Library of Congress Subject Headings (LCSH): | Interest rates -- Mathematical models -- United States | ||||||
Journal or Publication Title: | IMF Economic Review | ||||||
Publisher: | Palgrave Macmillan Ltd. | ||||||
ISSN: | 2041-4161 | ||||||
Official Date: | 25 November 2016 | ||||||
Dates: |
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Volume: | 64 | ||||||
Number: | 4 | ||||||
Page Range: | pp. 732-776 | ||||||
DOI: | 10.1057/s41308-016-0020-2 | ||||||
Status: | Peer Reviewed | ||||||
Publication Status: | Published | ||||||
Access rights to Published version: | Restricted or Subscription Access | ||||||
Date of first compliant deposit: | 14 September 2016 | ||||||
Date of first compliant Open Access: | 25 November 2017 |
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