A hybrid spline-based parametric model for the yield curve

This paper quantitatively explores the role of external habits, nominal rigidities, and monetary policy for real and nominal bond yields in an asset-pricing endogenous growth model. The calibration captures the reported average positive slopes of U.S. real and nominal yield curves with sizable positive real and nominal bond risk premia. Habits are critical to generate positive real premia by altering the comovement of real rates and productivity shocks. Nominal rigidities generate monetary policy effects on real bonds. Stronger policy rule inflation responses or weaker output responses increase real term premia and reduce inflation risk premia. Relative to standard models, the paper provides an alternative interpretation of real and nominal bond risks. This paper was accepted by Tomasz Piskorski, finance.

PurposeThis paper aims to study the asset pricing implications for stock and bond markets in a long-run risks (LRR) model with regime shifts. This general equilibrium framework can not only generate sign-switching stock-bond correlations and bond risk premium, but also quantitatively reproduce various other salient empirical features in stock and bond markets, including time-varying equity and bond return premia, regime shifts in real and nominal yield curves, the violation of the expectations hypothesis of bond returns.Design/methodology/approachThe researchers study the joint determinants of stock and bond returns in a LRR model framework with regime shifts in consumption and inflation dynamics. In particular, the means, volatilities, and the correlation structure between consumption growth and inflation are regime-dependent.FindingsThe model shows that the term structure of interest rates and stock-bond correlation are intimately related to business cycles, while LRR play a more important role in accounting for high equity premium than do business cycle risks.Originality/valueThis paper studies the joint determinants of stock and bond returns in a Bansal and Yaron (2004) type of LRR framework. This rational expectations general equilibrium framework can (1) jointly match the dynamics of consumption, inflation and cash flow; (2) generate time-varying and sign-switching stock and bond correlations, as well as generating sign-switching bond risk premium; and (3) coherently explain another long list of salient empirical features in stock and bond markets, including time-varying equity and bond return premia, regime shifts in real and nominal yield curves, the violation of the expectations hypothesis of bond returns.

The links between real and nominal bond risk premia and macroeconomic dynamics are explored quantitatively in a model with nominal rigidities and monetary policy. The estimated model captures macroeconomic and yield curve properties of the U.S. economy, implying significantly positive real term and inflation risk bond premia. In contrast to previous literature, both premia are positive and generated by wage rigidities as a compensation for permanent productivity shocks. Stronger policy-rule responses to inflation (output) increase (decrease) both premia, while policy surprises generate negligible risk premia. Empirical evidence of the economic mechanism is provided.

Decomposing nominal and real yield curves and inflation forecasting: Evidence from Brazil

The Term Structure of Inflation Expectations

This chapter introduces some important conceptual, descriptive, and theoretical considerations regarding nominal government bond yield curves. Conceptually, just what is it that are we trying to measure? How can we best understand many bond yields at many maturities over many years? Descriptively, how do yield curves tend to behave? Can we obtain simple yet accurate dynamic characterizations and forecasts? Theoretically, what governs and restricts yield curve shape and evolution? Can we relate yield curves to macroeconomic fundamentals and central bank behavior? The discussions cover three interest rate curves, zero-coupon yields, yield curve facts, yield curve factors, and yield curve questions.

Extracting Inflation Expectations and Inflation Risk Premia from the Term Structure: A Joint Model of the UK Nominal and Real Yield Curves

Regime Shifts in a Long-run Risks Model of U.S. Stock and Treasury Bond Markets

Switching Monetary Policy Regimes and the Nominal Term Structure

Reactions of Real Yields and Inflation Expectations to Forward Guidance in the United States

The term structure of interest rates, i.e., yield curve, has long been of interest to monetary policymakers and their advisers. The transmission of monetary is conventionally viewed as running from shortterm interest rates managed by central banks to longer-term rates that influence aggregate demand. A central bank's leverage over longer-term rates comes from fact that market determines these as average expected level of short rates over relevant horizon (abstracting from a term premium and default risk). Working in other direction, long bond rate contains a premium for expected and, thus, serves as an indicator of credibility of a central bank's commitment to low inflation.1 Different theoretical perspectives support two above-mentioned uses of term structure for monetary policy: John Hicks's (1939) expectations theory of term structure supports first, and Irving Fisher's (1896) decomposition of nominal bond rates into expected and an expected real return supports second.2 The two views are compatible in principle, although reconciling them creates difficulties of interpretation in practice. For example, does a steepening yield curve indicate a loss of confidence in central bank's commitment to low inflation, or does it indicate that markets expect tighter in form of a higher path of short rates pursued by central bank? The yield curve contains information of use to monetary policymakers, but it needs to be interpreted in light of judicious subsidiary identifying conditions, together with other data on economy. Some circumstances lend themselves to clearer interpretations than others, and there are many pitfalls. Whether or not one regards longer-term interest rates as economic indicators or as part of transmission mechanism for policy, or both, term structure plays a potentially important role in policymaking process. In spite of its complexity, term structure cannot be ignored. This article addresses some issues involved in using term structure to conduct monetary policy. I begin by discussing long bond rate as an indicator of expectations. Second, I comment on role that bond rates have played in recent U.S. monetary history. Third, I explain how information in yield curve can be used to overcome what I call policy in pipeline problem. Fourth, I review recent empirical evidence supporting two theoretical views underlying our understanding of term structure. I explain how peso problems associated with inflation scares in bond market may help to account for a serious empirical failure of expectations theory of term structure. I also discuss evidence supporting view that significant movements in long-term interest rates are largely driven by expected inflation. Finally, I point out some pitfalls of using term structure to make tactical decisions. 1. PURSUING LOW INFLATION The Chairman of Federal Reserve Board, Alan Greenspan, supports a longrun goal for price stability such that the expected rate of change of general level of prices ceases to be a factor in individual and business decisionmaking.3 The long bond rate is particularly well suited to help a central bank assess degree to which it has achieved low defined in that way. One could compare behavior of yield on a long-term nominal bond to its behavior in a past period in which was very low and public was reasonably confident that it would stay low. For instance, in United States 30-year nominal bond rate ranged from around 3 percent to a little over 4 percent from mid-1950s until mid-1960s, a period in which averaged around 1 to 2 percent, and presumably, long-term expectations were no more than that.4 One would think that if Federal Reserve (the Fed) were to achieve full credibility for low inflation, long bond rate would once again move down to 3 to 4 percent range. …

We propose a DSGE model with regime switching in the central bank’s inflation target to explain inflation compensation in the UK. Taking advantage of the well-documented change in UK monetary policy to adopt inflation targeting, we estimate our model using nominal and inflation-linked Treasury bond data from the UK from 1985 to 2007. We find that this model can account for the term structure of inflation compensation in the nominal yield curve by generating regime-dependent conditional expectations of future inflation.

Macroeconomic Volatility and Asset Prices Andrey Ermolov This dissertation investigates, both theoretically and empirically, how does the macroeconomic volatility, in particular, consumption growth, GDP growth and inflation volatility, affect asset prices in equity, bond and currency markets. In all three chapters of the dissertation I use the Bad Environment-Good Environment structure of Bekaert and Engstrom (2014) to model macroeconomic volatility. The key advantage of the approach is that it allows to model non-Gaussian features important in macroeconomic dynamics while yielding closed-form asset pricing solutions and being relatively efficient to estimate. In the first chapter of the dissertation I show that an external habit model augmented with a heteroskedastic consumption growth process reproduces well known domestic and international bond market puzzles, considered difficult to replicate simultaneously. Domestically, the model generates an upward sloping real yield curve and realistic violations of the expectation hypothesis. Depending on the parameters, the model can also generate a downward sloping real yield curve and predicts that the expectation hypothesis violations are stronger in countries with upward sloping real yield curves. Internationally, the model explains violations of the uncovered interest rate parity. Unlike a standard habit model, the model simultaneously features intertemporal smoothing to match domestic real yield curve slope and bond return predictability and precautionary savings to reproduce international predictability. The model also replicates the imperfect correlation between consumption and bond prices/exchange rates through positive and negative consumption shocks affecting habit differently. Empirical support for the model mechanisms is provided. In the second chapter, coauthored with my advisor Geert Bekaert and Eric Engstrom of Board of Governors of the Federal Reserve System, we extract aggregate supply and demand shocks for the US economy from data on inflation and real GDP growth. Imposing minimal theoretical restrictions, we obtain identification through exploiting non-Gaussian features in the data. The risks associated with these shocks together with expected inflation and expected economic activity are the key factors in a tractable no-arbitrage term structure model. Despite non-Gaussian dynamics in the fundamentals, we obtain closed-form solutions for yields as functions of the state variables. The time variation in the covariance between inflation and economic activity, coupled with their non-Gaussian dynamics leads to rich patterns in inflation risk premiums and the term structure. The macro variables account for over 70% of the variation in the levels of yields, with the bulk attributed to expected GDP growth and inflation. In contrast, macro risks predominantly account for the predictive power of the macro variables for excess holding period returns. In the final chapter, I embed the macroeconomic dynamics from the second chapter into an external habit model to analyze the time-varying stock and bond return correlations. Despite featuring flexible non-Gaussian fundamental processes, the model can be solved in closed-form. The estimation identifies time-varying ”demand-like” and ”supply-like” macroeconomic shocks directly linked to the risk of nominal assets and matches standard properties of US stock and bond returns. I find that macroeconomic shocks generate sizeable positive and negative correlations, although negative correlations occur less frequently and are smaller than in data. Historically, macroeconomic shocks are most important in explaining high correlations from the late 70’s until the early 90’s and low correlations preand during the Great Recession.

This dissertation explores how central bank communication influences financial markets, focusing on the transmission of information through policy statements, program announcements, and forward guidance. By combining event-study methodologies, yield curve modeling, and volatility analysis, the research investigates how financial market participants interpret and react to central bank messages in both the United States and the Euro area. The analysis covers bond yields, stock market volatility, and broader implications for monetary transmission under different policy environments. The first empirical study examines yield reactions to forward guidance in the United States. Using high-frequency data surrounding Federal Reserve announcements, it quantifies the immediate impact of forward-looking policy statements on Treasury yields across maturities. Employing an event-study framework and regression-based sensitivity analysis, the study finds that forward guidance substantially alters market expectations of the future policy rate path. Short- and medium-term maturities exhibit the strongest yield responses, indicating that communication about the timing and persistence of policy normalization is a critical driver of bond market pricing. The findings confirm that the tone, clarity, and credibility of central bank statements shape the effectiveness of forward guidance as a monetary policy tool. The second part extends the analysis to the Euro area, investigating yield reactions to European Central Bank (ECB) program announcements, such as the Securities Markets Programme (SMP), the Outright Monetary Transactions (OMT), and the Asset Purchase Programme (APP). Through a carefully constructed event dataset and multiple regression specifications, the study isolates announcement effects on sovereign yields across member states. Results show significant yield compression following announcements of unconventional policy programs, particularly in stressed sovereign markets. Panel regressions further reveal that countries with higher yield spreads experience stronger reactions, confirming the credibility and signaling effects of ECB interventions. Moreover, robustness checks confirm that program-specific and timing-related factors play a central role in determining the magnitude of market responses. The third empirical study investigates how ECB communication affects the entire yield curve. It develops a model linking communication tone, timing, and policy content to shifts in the level, slope, and curvature of the Euro area yield curve. The analysis demonstrates that clear and consistent communication reduces uncertainty in expectations and flattens the yield curve, signaling confidence in policy continuity. Conversely, ambiguous or surprise statements tend to steepen the curve and increase market volatility. These results emphasize the role of transparency and consistency in anchoring interest rate expectations, particularly in periods of unconventional monetary policy. The fourth study focuses on the effects of ECB announcements on stock market volatility. Utilizing multiple measures—high-frequency realized volatility, daily price ranges, future and implied volatility indices—the research examines how equity markets respond to policy communications over time. The results indicate that monetary policy announcements have statistically significant effects on volatility, especially during crisis and post-crisis periods. Positive announcements (e.g., expansionary or supportive policies) tend to reduce volatility, while negative or tightening-related communications heighten it. The study also explores asymmetric effects, persistence over subsequent days, and the weighting of announcement content, revealing that market sensitivity depends on both the perceived economic outlook and the credibility of policy measures. Across all four studies, the findings collectively underscore that central bank communication is a powerful instrument of monetary policy—capable of moving markets even in the absence of traditional rate changes. The magnitude and direction of financial market reactions depend on message clarity, policy credibility, and prevailing market conditions. The research highlights that well-calibrated communication enhances the predictability of monetary policy, stabilizes expectations, and reduces excess volatility. In contrast, ambiguity or inconsistency can amplify uncertainty and undermine transmission effectiveness. The dissertation contributes to the literature by providing a comprehensive cross-market and cross-institutional analysis of how communication serves as a vital, yet complex, channel of modern monetary policy in both normal and crisis periods.

Economic Determinants of the Nominal Treasury Yield Curve