Recent Posts

Glenn Rudebusch and I finished a new version of our paper “Interest Rates Under Falling Stars” which includes a lot of new material. Among other things we included various new estimates of the equilibrium real interest rate, \(r^\ast\), and we developed a new model for the yield curve that allows for shifting long-run trends and provides a Bayesian estimate of the equilibrium nominal interest rate \(i^\ast\). You can download the new version of the paper here.

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Thomas and I wrote a second Economic Letter about the information in the yield curve for predicting recessions. Here we focus on what different measure of the shape of the yield curve—that is, which yield spread—appears to have the most information. We conclude that the classic 10-year minus 3-month spread is the most useful one. We also discuss the role of the term premium, and how to interpret this evidence. (Correlation is not causation!

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Thomas Mertens and I wrote an Economic Letter on predictings recessions with the yield curve. There has been a lot of public discussion about whether a flat yield curve contains a strong signal about a future economic slowdown. We found that the predictive power of the yield curve for future economic activity and recessions is very strong, and remains strong even in the current environment with a low overall level of interest rates, a low term premium, and other somewhat unique circumstances.

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Why have long-term interest rates been falling throughout much of 2017, while the Federal Reserve has been normalizing monetary policy? At first sight, the combination of rising short rates and falling long rates seems puzzling, and even vaguely reminiscent of the famous Greenspan conundrum. But this time around, there are some good reasons that explain the flattening of the yield curve, which I discuss in my most recent Economic Letter.

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Selected Publications

Restrictions on the risk-pricing in dynamic term structure models (DTSMs) tighten the link between cross-sectional and time-series variation of interest rates, and make absence of arbitrage useful for inference about expectations. This article presents a new econometric framework for estimation of affine Gaussian DTSMs under restrictions on risk prices, which addresses the issues of a large model space and of model uncertainty using a Bayesian approach. A simulation study demonstrates the good performance of the proposed method. Data for U.S. Treasury yields calls for tight restrictions on risk pricing: only level risk is priced, and only changes in the slope affect term premia. Incorporating the restrictions changes the model-implied short-rate expectations and term premia. Interest rate persistence is higher than in a maximally flexible model, hence expectations of future short rates are more variable—restrictions on risk prices help resolve the puzzle of implausibly stable short-rate expectations in this literature. Consistent with survey evidence and conventional macro wisdom, restricted models attribute a large share of the secular decline in long-term interest rates to expectations of future nominal short rates.
In Journal of Business and Economic Statistics, 2018.

A consensus has recently emerged that variables beyond the level, slope, and curvature of the yield curve can help predict bond returns. This paper shows that the statistical tests underlying this evidence are subject to serious small-sample distortions. We propose more robust tests, including a novel bootstrap procedure specifically designed to test the spanning hypothesis. We revisit the analysis in six published studies and find that the evidence against the spanning hypothesis is much weaker than it originally appeared. Our results pose a serious challenge to the prevailing consensus.
In Review of Financial Studies, 2017.

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