Volatility-Induced Stationarity and Error-Correction in Macro-Finance Term Structure Modeling

Research output: Working paperResearch

  • Anne Lundgaard Hansen
It is well-known that interest rates and inflation rates are extremely persistent, yet they are best modeled and understood as stationary processes. These properties are contradictory in the workhorse Gaussian affine term structure model in which the persistent data often result in unit roots that imply non-stationarity. We resolve this puzzle by proposing a macro-finance term structure model with volatility-induced stationarity. Our model employs a level-dependent conditional volatility that maintains stationarity despite presence of unit roots in the characteristic polynomial corresponding to the conditional mean. Compared to the Gaussian affine term structure model, we improve out-of-sample forecasting of the yield curve and estimate term premia that are economically plausible and consistent with survey data. Moreover, we show that volatility-induced stationarity affects the error-correcting mechanism in a system of interest rates, inflation, and real activity.
Original languageEnglish
Number of pages31
DOIs
Publication statusPublished - 3 Dec 2018
SeriesUniversity of Copenhagen. Institute of Economics. Discussion Papers (Online)
Number18-12
ISSN1601-2461

    Research areas

  • Faculty of Social Sciences - Yield curve, error-correction, unit root, volatility-induced stationarity, macro-finance term structure model, evel-dependent conditional volatility

ID: 210006157