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A Joint Econometric Model of Macroeconomic and Term Structure Dynamics
 Journal of Econometrics
, 2006
"... In 2004 all publications will carry a motif taken from the €100 banknote. This paper can be downloaded without charge from ..."
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Cited by 108 (3 self)
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In 2004 all publications will carry a motif taken from the €100 banknote. This paper can be downloaded without charge from
The Term Structure of Real Rates and Expected Inflation
, 2004
"... Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, timevarying prices of risk, and inflation to identify these components of the nominal yield curve. We ..."
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Cited by 108 (15 self)
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Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, timevarying prices of risk, and inflation to identify these components of the nominal yield curve. We find that the unconditional real rate curve is fairly flat at 1.44%, but slightly humped. In one regime, the real term structure is steeply downward sloping. Real rates (nominal rates) are procyclical (countercyclical) and inflation is negatively correlated with real rates. An inflation risk premium that increases with the horizon fully accounts for the generally upward sloping nominal term structure. We find that expected inflation drives about 80 % of the variation of nominal yields at both short and long maturities, but during normal times, all of the
Why is longhorizon equity less risky? A durationbased explanation of the value premium, NBER working paper
, 2005
"... We propose a dynamic riskbased model that captures the value premium. Firms are modeled as longlived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model im ..."
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Cited by 100 (20 self)
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We propose a dynamic riskbased model that captures the value premium. Firms are modeled as longlived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model implies that growth firms covary more with the discount rate than do value firms, which covary more with cash flows. When calibrated to explain aggregate stock market behavior, the model accounts for the observed value premium, the high Sharpe ratios on value firms, and the poor performance of the CAPM. THIS PAPER PROPOSES A DYNAMIC RISKBASED MODEL that captures both the high expected returns on value stocks relative to growth stocks, and the failure of the capital asset pricing model to explain these expected returns. The value premium, first noted by Graham and Dodd (1934), is the finding that assets with a high ratio of price to fundamentals (growth stocks) have low expected returns relative to assets with a low ratio of price to fundamentals (value stocks). This
Risk Premiums in Dynamic Term Structure Models with . . .
, 2010
"... This paper quantifies how variation in real economic activity and inflation in the U.S. influenced the market prices of level, slope, and curvature risks in U.S. Treasury markets. To accomplish this we develop a novel arbitragefree DT SM in which macroeconomic risks – in particular, real output and ..."
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Cited by 64 (10 self)
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This paper quantifies how variation in real economic activity and inflation in the U.S. influenced the market prices of level, slope, and curvature risks in U.S. Treasury markets. To accomplish this we develop a novel arbitragefree DT SM in which macroeconomic risks – in particular, real output and inflation risks – impact bond investment decisions separately from information about the shape of the yield curve. Estimates of our preferred macroDT SM over the twentythree year period from 1985 through 2007 reveal that unspanned macro risks explained a substantial proportion of the variation in forward terms premiums. Unspanned macro risks accounted for nearly 90 % of the conditional variation in shortdated forward term premiums, with unspanned real economic growth being the key driving factor. Over horizons beyond three years, these effects were entirely attributable to unspanned inflation. Using our model, we also reassess some of Chairman Bernanke’s remarks on the interplay between term premiums, the shape of the yield curve, and macroeconomic activity.
Regime shifts in a dynamic term structure model of U.S. Treasury bond yields, Working paper, Stern School of Business
, 2003
"... This paper develops and empirically implements an arbitragefree, dynamic term structure model with “priced ” factor and regimeshift risks. The risk factors are assumed to follow a discretetime Gaussian process, and regime shifts are governed by a discretetime Markov process with statedependent ..."
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Cited by 62 (4 self)
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This paper develops and empirically implements an arbitragefree, dynamic term structure model with “priced ” factor and regimeshift risks. The risk factors are assumed to follow a discretetime Gaussian process, and regime shifts are governed by a discretetime Markov process with statedependent transition probabilities. This model gives closedform solutions for zerocoupon bond prices and an analytic representation of the likelihood function for bond yields. Using monthly data on U.S. Treasury zerocoupon bond yields, we document notable differences in the behaviors of the market prices of factor risk across high and low volatility regimes. Additionally, the statedependence of the regimeswitching probabilities is shown to capture an interesting asymmetry in the cyclical behavior of interest rates. The shapes of the term structures of bond yield volatilities are also very different across regimes, This paper develops and empirically implements an arbitragefree, dynamic term structure model (DTSM) with “priced ” factor and regimeshift risks. The risk factors are assumed to follow a discretetime Gaussian process, and regime shifts are governed by a discretetime Markov process with statedependent transition probabilities. Agents are assumed to know
The Term Structures of Equity and Interest Rates
, 2007
"... This paper proposes a dynamic riskbased model capable of jointly explaining the term structure of interest rates, returns on the aggregate market and the risk and return characteristics of value and growth stocks. Both the term structure of interest rates and returns on value and growth stocks conv ..."
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Cited by 37 (5 self)
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This paper proposes a dynamic riskbased model capable of jointly explaining the term structure of interest rates, returns on the aggregate market and the risk and return characteristics of value and growth stocks. Both the term structure of interest rates and returns on value and growth stocks convey information about how the representative investor values cash flows of different maturities. We model how the representative investor perceives risks of these cash flows by specifying a parsimonious stochastic discount factor for the economy. Shocks to dividend growth, the real interest rate, and expected inflation are priced, but shocks to the price of risk are not. Given reasonable assumptions for dividends and inflation, we show that the model can simultaneously account for the behavior of aggregate stock returns, an upwardsloping yield curve, the failure of the expectations hypothesis and the poor performance of the capital asset pricing model.
Credit risk modeling and valuation: an introduction
 In D. Shimko. Credit Risk: Models and Management
, 2004
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Understanding the Role of Recovery in Default Risk Models: Empirical Comparisons and Implied Recovery Rates
, 2006
"... This article presents a framework for studying the role of recovery on defaultable debt prices for a wide class of processes describing recovery rates and default probability. These debt models have the ability to differentiate the impact of recovery rates and default probability, and can be employe ..."
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Cited by 35 (0 self)
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This article presents a framework for studying the role of recovery on defaultable debt prices for a wide class of processes describing recovery rates and default probability. These debt models have the ability to differentiate the impact of recovery rates and default probability, and can be employed to infer the market expectation of recovery rates implicit in bond prices. Empirical implementation of these models suggests two central findings. First, the recovery concept that specifies recovery as a fraction of the discounted par value has broader empirical support. Second, parametric debt valuation models can provide a useful assessment of recovery rates embedded in bond prices.
Guaranteed Annuity Options
 ASTIN Bulletin
, 2003
"... Under a guaranteed annuity option, an insurer guarantees to convert a policyholder’s accumulated funds to a life annuity at a fixed rate when the policy matures. If the annuity rates provided under the guarantee are more beneficial to the policyholder than the prevailing rates in the market the insu ..."
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Cited by 29 (0 self)
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Under a guaranteed annuity option, an insurer guarantees to convert a policyholder’s accumulated funds to a life annuity at a fixed rate when the policy matures. If the annuity rates provided under the guarantee are more beneficial to the policyholder than the prevailing rates in the market the insurer has to make up the difference. Such guarantees are common in many US tax sheltered insurance products. These guarantees were popular in UK retirement savings contracts issued in the 1970’s and 1980’s when longterm interest rates were high. At that time, the options were very far out of the money and insurance companies apparently assumed that interest rates would remain high and thus that the guarantees would never become active. In the 1990’s, as longterm interest rates began to fall, the value of these guarantees rose. Because of the way the guarantee was written, two other factors influenced the cost of these guarantees. First, strong stock market performance meant that the amounts to which the guarantee applied increased significantly. Second, the mortality assumption implicit in the guarantee did not anticipate the improvement in mortality which actually occurred. The emerging liabilities under these guarantees threatened the solvency of some companies 1
Design and Estimation of Quadratic Term Structure Models
, 2001
"... We consider the design and estimation of quadratic term structure models. We start with a list of stylized facts on interest rates and interest rate derivatives, classified into three layers: (1) general statistical properties, (2) forecasting relations, and (3) conditional dynamics. We then investi ..."
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Cited by 28 (6 self)
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We consider the design and estimation of quadratic term structure models. We start with a list of stylized facts on interest rates and interest rate derivatives, classified into three layers: (1) general statistical properties, (2) forecasting relations, and (3) conditional dynamics. We then investigate the implications of each layer of property on model design and strive to establish a mapping between evidence and model structures. We calibrate a twofactor model that approximates these three layers of properties well, and illustrate how the model can be applied to pricing interest rate derivatives.