DP5341 Term Structure Estimation with Survey Data on Interest Rate Forecasts

Author(s):	Don H. Kim, Athanasios Orphanides
Publication Date:	November 2005
Keyword(s):	Dynamic term structure models, expectations hypothesis, interest rate forecasts, survey data, term premia
JEL(s):	E43, E47, G12
Programme Areas:	International Macroeconomics, Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=5341

The estimation of dynamic no-arbitrage term structure models with a flexible specification of the market price of risk is beset by a severe small-sample problem arising from the highly persistent nature of interest rates. We propose using survey forecasts of a short-term interest rate as an additional input to the estimation to overcome the problem. The three-factor pure-Gaussian model thus estimated with the U.S. Treasury term structure for the 1990-2003 period generates a stable estimate of the expected path of the short rate, reproduces the well-known stylized patterns in the expectations hypothesis tests, and captures some of the short-run variations in the survey forecast of the changes in longer-term interest rates.