This paper presents an essentially affine model of the term structure of interest rates making use of macroeconomic factors and their long-run expectations. The model extends the approach pioneered by Kozicki and Tinsley (2001) by modeling consistently long-run inflation expectations simultaneously with the term structure. This model thus avoids the standard pre-filtering of long-run expectations, as proposed by Kozicki and Tinsley (2001). Application to the U.S. economy shows the importance of long-run inflation expectations in the modelling of long-term bonds. The paper also provides a macroeconomic interpretation for the factors found in a latent factor model of the term structure. More specifically, we find that the standard "level" factor is highly correlated to long-run inflation expectations, the "slope" factor captures temporary business cycle conditions, while the "curvature" factor represents a clear independent monetary policy factor.

Essentially affine term structure model, long-run market expectations, macroeconomic factors, monetary policy rule
Determination of Interest Rates; Term Structure of Interest Rates (jel E43), Financial Markets and the Macroeconomy (jel E44), Monetary Policy (Targets, Instruments, and Effects) (jel E52), Corporate Finance and Governance (jel G3), Business Administration and Business Economics; Marketing; Accounting (jel M), Accounting (jel M41)
ERIM Report Series Research in Management
Erasmus Research Institute of Management

Dewachter, H.D.R, & Lyrio, M. (2003). Macro factors and the Term Structure of Interest Rates (No. ERS-2003-037-F&A). ERIM Report Series Research in Management. Retrieved from