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Accounting for a Shift in Term Structure Behavior with No-Arbitrage and Macro-Finance Models


  • For helpful comments, we thank many colleagues in the Federal Reserve System as well as seminar and conference participants at Bocconi University, the Federal Reserve Board, the European Central Bank, and the NBER Summer Institute. Golnaz Motiey and Vuong Nguyen provided excellent research assistance. The views expressed in this paper do not necessarily reflect those of others in the Federal Reserve System.


This paper examines a shift in the dynamics of the term structure of interest rates in the United States during the mid-1980s. We document this shift using standard interest rate regressions and using dynamic, affine, no-arbitrage models estimated for the pre- and post-shift subsamples. The term structure shift largely appears to be the result of changes in the pricing of risk associated with a “level” factor. Using a macro-finance model, we suggest a link between this shift in term structure behavior and changes in the dynamics and risk pricing of the Federal Reserve's inflation target as perceived by investors.

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