hero working papers

Taylor Rules and the Term Structure

Number: 195
Year: 2001
Author(s): Carlo Ambrogio Favero(Università Bocconi, IGIER)
The expectations model of the term structure of interest rates has been subjected to numerous empirical tests and almost invariably rejected.
In fact, the vast majority of the empirical evidence is based on the estimation of single-equation models and on the assumption that realized returns are a valid proxy for expected returns. A recent strand of the macroeconomic literature has analyzed monetary policy by including the central bank reaction function in small empirical macro models.
By simulating these models forward it is possible to derive the full forward path of short-term interest rates and hence to construct any long-term yields using model based forecasts. A test of the theory can then be performed by comparing observed long-term yield with those simulated and the associated 95 per cent confidence interval.
The application of this framework to the analysis of US term structure in the nineties does not
lead to the rejection of the expectations mode