UK Macroeconomic Volatility and the Term Structure of Interest Rates

Authors


  • I am grateful to Karim Abadir, Martin Ellison, John Hutton, Marcus Miller, Zhuoshi Liu, Peter Smith, Andy Tremayne, Mike Wickens and participants in the Money Macro Finance 2010 Conference for helpful comments. I am particularly indebted to a referee of this Bulletin for comments on an earlier draft of this paper.

Abstract

This study uses a macro-finance model to examine the ability of the gilt market to predict fluctuations in macroeconomic volatility. The econometric model is a development of the standard ‘square root’ volatility model, but unlike the conventional term structure specification it allows for separate volatility and inflation trends. It finds that although volatility and inflation trends move independently in the short run, they are cointegrated. Bond yields provide useful information about macroeconomic volatility, but a better indicator can be developed by combining this with macroeconomic information.

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