The Macroeconomy and the Yield Curve: A Dynamic Latent Factor Approach

S. Boragan Aruoba, Francis X. Diebold and Glenn D. Rudebusch , Journal of Econometrics 131(1-2) , 309-338 , March 2006.

We estimate a model that summarizes the yield curve using latent factors (specifically, level, slope, and curvature) and also includes observable macroeconomic variables (specifically, real activity, inflation, and the monetary policy instrument). Our goal is to provide a characterization of the dynamic interactions between the macroeconomy and the yield curve. We find strong evidence of the effects of macro variables on future movements in the yield curve and evidence for a reverse influence as well. We also relate our results to the expectations hypothesis.

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