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An Extended Macro-Finance Model with Financial Factors

Published online by Cambridge University Press:  07 June 2011

Hans Dewachter  and
Leonardo Iania
Hans Dewachter
Affiliation:
National Bank of Belgium, de Berlaimontlaan 14, 1000 Brussels, Belgium, Katholieke Universiteit Leuven, and CESifo Group. [email protected]
Leonardo Iania
Affiliation:
Center for Economic Studies, Katholieke Universiteit Leuven, Naamsestraat 69, 3000 Leuven, Belgium, and Maastricht University. [email protected]
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Abstract

This paper extends the benchmark macro-finance (MF) model by introducing, next to the standard macroeconomic factors, additional liquidity-related and return-forecasting factors. Liquidity factors are obtained from a decomposition of the money market spread, while the return-forecasting (risk premium) factor is extracted by imposing a single-factor structure on the 1-period expected excess holding return. The model is estimated on U.S. data using Markov chain Monte Carlo techniques. Two findings stand out. First, the model significantly outperforms most structural and nonstructural MF yield curve models in terms of the cross-sectional fit of the yield curve. Second, financial shocks have a statistically and economically significant impact on the yield curve.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 46 , Issue 6 , December 2011 , pp. 1893 - 1916
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

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