Topics on Macroeconomics II Bond Markets, Macro Finance Term Structure Models and Applications Spring 2012 WISE, Xiamen University Taught by Linlin Niu Time and location: Tuesday and Thursday 14:30 16:10, Nanqiang 2, R401. Evaluation on student s participation: class participation and presentation 50%, term paper 50%. Course Description Term structure of interest rates, or equivalently the yield curve, illustrates the relationship between interest rates and time to maturities, i.e. the remaining time until a bond expires. At the short end of the yield curve, the short term interest rate is closely related to monetary policy, which reacts to macroeconomic fundamentals such as inflation and growth. In equilibrium, long term interest rate is weighted expectation of future short term interest rates adjusted by risks and risk compensation. Moreover, the treasury yield curve provides a benchmark for interest rates, upon which asset of different risk characters and derivatives based on essential assets are priced. Financial markets are built around and convoluted with this curve. The yield curve is like a crystal ball containing important information on the dynamics of the economy, its risk perspective and investors risk appetite. Deciphering and understanding the information is of crucial importance to policy makers, investors, firms and households. This course serves as a starting point to deciphering and understanding this crystal ball. To this end, we need to go through four aspects: - Theory, which provides a unified framework of macro finance models; - Practice, which gives the basics on market functions and mechanism; - Techniques, which consist of models and methodologies; and finally - Questions, among which some interesting and important issues will be investigated with the theory and techniques we just acquired. 1
Outline and Readings 1. Framework 1.1 Introduction (Class 1) 1.2 Consumption-Based Model and Discount Factor (Classes 2-5) John H. Cochrane, Asset Pricing (Revised), 2005, Princeton University Press. Chapters 1-4. 2. Introduction on Bond Markets Suresh Sundaresan, Fixed Income Markets and Their Derivatives, Third Edition. Elsevier. 2009. Chapter 1-13. (Classes 6 12) 3. Models 3.1 Reduced form (Classes 13 14) Nelson, C.R. and A.F. Siegel, (1987) "Parsimonious modelling of yield curves", Journal of Business, 60, 473-489. Cochrane, J. And M. Piazzesi, (2005) "Bond risk premia", American Economic Review, Volume 95, Issue 1, pp. 138-160. Ang, A. And G. Bekaert, (2002) "Regime Switches in Interest Rates", Journal of Business and Economic Statistics, 20, 2, 163-182. 3.2 No-arbitrage (2 3 classes) Piazzesi, M. (2003) Affine Term Structure Models, in the Handbook of Financial Econometrics, Elsevier. Dai, Q. And K.J. Singleton, (2000) Specification Analysis of Affine Term Structure Models, Journal of Finance. Dai, Q. And K.J. Singleton, (2003) Term Structure Dynamics in Theory and Reality, Review of Financial Studies, Vol 16, pp 631-678. Ang, A. And M. Piazzesi, (2003) A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables." Journal of Monetary Economics, Volume 50, Issue 4, May 2003, 745-787. Diebold, F., G. Rudebusch and M. Piazzesi, (2005) Modeling Bond Yields in Finance and Macroeconomics, American Economic Review P&P Volume 95, Issue 2, pp. 415-420. 2
Rudebusch, G., E. Swanson, (2006) "The Bond Yield "Conundrum" from a Macro-Finance Perspective," Monetary and Economic Studies, 24(S-1), 83-128. Wachter, J.A. (2005) A Consumption-Based Model of the Term Structure of Interest Rates, Journal of Financial Economics, 79, 365-399. Piazzesi, M. And M. Schneider, (2006), Equilibrium Yield Curves, NBER Working Paper 12609. Ang, A., M. Piazzesi and M. Wei (2006) What does the yield curve tell us about GDP growth? Journal of Econometrics 2006, 131, pp. 359-403. Duffee, G. R., (2002), "Term Premia and Interest Rate Forecasts in Affine Models", Journal of Finance, 57, 405-443. Duffee, G. R., (2011), "Forecasting with the Term Structure: The Role of No-arbitrage Restrictions", Working paper, Johns Hopkins University. 3.3 A merge of Nelson-Siegel class of models and no-arbitrage models ( 1 2 classes) Christensen, J. H. E., F. X. Diebold and G. D. Rudebusch (2009), An Arbitrage-Free Generalized Nelson-Siegel term structure model, Econometrics Journal, 1, 1-31. Christensen, J. H. E., F. X. Diebold and G. D. Rudebusch (2010), The Affine Arbitrage-Free Class of Nelson-Siegel Term Structure Models, forthcoming in Journal of Econometrics. (Orginal version: NBER Working Paper No. 13611) Niu, L. and G. Zeng (2012), The Discrete-time Affine Arbitrage-free Nelson-Siegel Class of Term Structure Models, working paper. Li, C., L. Niu and G. Zeng, (2011), A Generalized Arbitrage-Free Nelson-Siegel Term Structure Model with Macroeconomic Fundamentals, working paper. 4. Estimation methodologies 4.1 OLS, NLS, GMM, MLE (1 2 classes) Nelson, C.R. and A.F. Siegel, (1987) "Parsimonious modelling of yield curves", Journal of Business, 60, 473-489. Ang, A. And M. Piazzesi, (2003) A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables." Journal of Monetary Economics, Volume 50, Issue 4, May 2003, 745-787. Hamilton, J. D. and J. C. Wu, "Identification and Estimation of Gaussian Affine Term Structure Models" (December 11, 2010). Chicago Booth Research Paper No. 11-28. Available at SSRN: http://ssrn.com/abstract=1907718 4.2 Bayesian (1 class) Ang, A., S. Dong and M. Piazzesi, (2007) No-Arbitrage Taylor Rules, NBER Working paper 13448. Niu, L. and G. Zeng (2012), The Discrete-time Affine Arbitrage-free Nelson-Siegel Class of Term Structure Models, working paper. 3
5. Issues 5.1 Great Moderation (1 2 classes) Stock, J. H. and M. Watson, (2002) Has the Business Cycle Changed and Why? NBER Working Paper No. W9127. Primiceri, G., (2005) Time Varying Structural Vector Autoregressions and Monetary Policy. The Review of Economic Studies, 72, pp. 821-852 Primiceri, G. and A. Justiniano, (2008) The Time Varying Volatility of Macroeconomic Fluctuations. American Economic Review, 98(3), pp. 604-641 Benati, L. and P. Surico, (2009) "VAR Analysis and the Great Moderation." American Economic Review, 99(4): 1636 52. Taylor, J. (2010) Swings in the Rules-Discretion Balance, working paper, Stanford Uni. Niu, L., (2009) An Affine Term Structure Model with Auxiliary Stochastic Volatility-Covolatility. working paper. 5.2 Monetary policy (1 2 classes) Ang, A., S. Dong and M. Piazzesi, (2007) No-Arbitrage Taylor Rules, NBER Working paper 13448. Ang, A. Boivin, J. Dong, S. and Loo-Kung, R., (2011), "Monetary Policy Shifts and the Term Structure", Review of Economic Studies, 78, 2, 429-457. Mumtaz, H. And P. Surico, (2009) Time-Varying Yield Curve Dynamics and Monetary Policy, Journal of Applied Econometrics, 24-6, 895-931. Piazzesi, M. (2005) Bond Yields and the Federal Reserve, Journal of Political Economy, Volume 113, Issue 2, pp. 311-344. Sun, Z. (2012) Monetary Policy Transmission in a Segregated Interest Rate Markets in China, master thesis 5.3 Fiscal policy (1 2 classes) Dai, Q. and Philippon, T. (2004), Fiscal Policy and the Term Structure of Interest Rates, mimeo. Baldacci, E., S. Gupta and A. Mati (2010), Political and Fiscal Risk Determinants of Sovereign Spreads in Emerging Markets, Review of Development Economics, forthcoming. Baldacci, E. and M. S. Kumar (2010) Fiscal Deficits, Public Debt, and Sovereign Bond Yields, IMF WP/10/184. Favero C.A., F. Giavazzi (2011) "Measuring Tax Multipliers:the narrative Method in fiscal VARs" forthcoming the American Economic Journal, Economic Policy. 5.4 Open economy and exchange rates (1 2 classes) Diebold, F.X., C. Li and V. Yue (2008), "Global Yield Curve Dynamics and Interactions: A Generalized Nelson-Siegel Approach," Journal of Econometrics, 146, 351-363. Huang, S. and L. Niu (2011), A Tale of Three Currencies: US and Hong Kong s Yield 4
Curves under RMB Appreciation Pressure, Working Paper 5.5 Long run risk (1 class) Favero, C.A., A. Gozluklu and H. Yang (2011), Demographics and the Behaviour of Interest Rates, IGIER Working Paper 388. 5.6 Financial crisis and debt crisis (2 4 classes) Taylor J. and J. Williams (2008) "A Black Swan in the Money Market" Federal Reserve Bank of San Francisco Working Paper 2008-04. Taylor J. and J. Williams (2008) "Further Results on a Black Swan in the money market" mimeo Taylor, J. (2010) "Getting Back on Track: Macroeconomic Policy Lessons from the Financial Crisis" Stlouis FED Blanchard, O.(2008) "The Crisis, Basic Mechanism and Appropriate Policies", Munich Lecture IMF(2008) Fiscal Policy for the Crisis Muellbauer, J. (2011) "Resolving the euro-zone crisis. time for Conditional Eurobonds" CEPR Policy Insight. IESEG-Cambridge Conference papers on The Yield Curve and New Developments in Macro-finance: What have we learnt from the 2007-2010 financial crises? at http://international.ieseg.fr/teachers-and-research/ieseg-cambridge-conference/ 5.7 Forecast (1 2 classes) Favero, C., L. Sala and L. Niu (2012) Term Structure Forecasting: No-arbitrage Restrictions versus Large Information set, forthcoming in Journal of Forecasting. Chen, Y and L. Niu (2012) Adaptive Dynamic Nelson-Siegel Model with Applications, Working Paper. 5