Research Papers

Term Premia and the News (Job Market Paper)

How do short rate expectations and term premia respond to news? Dynamic term structure models typically imply that the term premium accounts for most of the procyclical response of long-term interest rates, which is at odds with the conventional wisdom about bond risk premia. Bias and lack of precision in the estimated short rate dynamics make it difficult to interpret this evidence. This paper solves these problems by imposing plausible zero restrictions on the market prices of risk. The no-arbitrage assumption becomes useful for estimation, because information in the cross section helps to pin down the dynamics of the short rate. Inference about term premia is performed in a Bayesian framework based on Markov Chain Monte Carlo methods. This allows the researcher to select plausible restrictions and to correctly quantify statistical uncertainty. The main empirical result is that under the restrictions favored by the data the expectations component, and not the term premium, accounts for the majority of high-frequency movements of long rates and for essentially all of their procyclical response to macroeconomic news.

Revisions to Short Rate Expectations: Policy Surprises and Macroeconomic News

How do interest rates react to monetary policy actions and macroeconomic news? The conventional event study approach has several shortcomings, and this paper presents an alternative framework to answer this question, based on a dynamic term structure model that recognizes the heterogeneity of news events. My approach imposes no-arbitrage, parsimoniously captures the revisions to the entire expected short rate path, and integrates the analysis of different types of news. Policy actions are found to affect the entire yield curve, and the impact does not decline with maturity as suggested by previous studies. The impact of macroeconomic announcements reflects the fact that policy inertia plays an important role in how markets form expectations. Policy news lead to more varied effects than macro news, indicating that markets are surprised along more than one dimension by actions of the Fed.

Work in Progress

Restrictions on the Market Prices of Risk in Macro-Finance Term Structure Models

A key challenge for macro-finance dynamic term structure models (DTSMs) is to put structure on the market prices of risk, since otherwise the number of free parameters is too large and the data is overfitted. I estimate a simple macro-finance DTSM involving latent term structure factors as well as observable macro variables, and impose plausible restrictions on the risk sensitivity parameters by applying methods of Bayesian model selection. In addition to leading to a more parsimonious and more reliably estimated model, this approach allows me to rigorously test restrictions on the prices of risk. In this way I can provide answers to the two key questions of macro-finance, namely which macroeconomic variables drive variation in risk premia, and which macroeconomic shocks carry risk.

No-Arbitrage Restrictions and Interest Rate Forecasting

Assuming absence of arbitrage does not automatically lead to better forecasts of interest rates, a fact which has been pointed out recently by several studies. However, since market prices of risk are usually unrestricted, conventional DTSMs do not make use of the no-arbitrage assumption for estimating the dynamic properties of interest rates. This paper presents a parsimonious forecasting model, in which the dynamic system is estimated more precisely and without the typical small-sample bias. This is achieved by imposing sensible zero restrictions on risk sensitivity parameters. Forecasts produced by the restricted DTSM are more accurate than those based on unrestricted DTSMs or alternative methods that do not impose no-arbitrage.

Calendar Effects in the Federal Funds Market: Evidence and Some Theory

The deviations of the effective federal funds rate from the target set by the FOMC show interesting calendar patterns in their first and second moments. This paper documents these calendar patterns and shows economically significant variations in the size of the target rate deviations over the course of the settlement period, as well as over the course of the calendar month, quarter and year. Of particular importance is a structural break due to the introduction of lagged reserve accounting in June 1998. An economic explanation of the empirical results is attempted, based on a theoretical model of bank reserves management.

Master Thesis

Testing for Endogenous Growth
(2004, published by VDM Publishing, Germany, ISBN 978-3-639-20683-8)

Models of endogenous growth have strong empirical predictions about the determinants of technological progress. This thesis details the implications of alternative R&D-based endogenous growth models, and then surveys the empirical literature that tests different aspects of this New Growth Theory. Numerous studies attempt to test the validity of endogenous growth models but come to very different conclusions, since varying hypotheses are considered. There are few rigorous and plausible empirical assessments of whether the determinants of technological progress conform to the predictions of the theory. I provide new evidence on the relevance of R&D intensity for economic growth, using dynamic panel data methods, thereby contributing to the empirical literature that finds support for R&D-based endogenous growth models.