#05-01
Modeling Bond Yields in Finance and Macroeconomics
Abstract: From a macroeconomic perspective, the short-term interest rate is a policy
instrument under the direct control of the central bank. From a finance perspective, long
rates are risk-adjusted averages of expected future short rates. Thus, as illustrated by much
recent research, a joint macro-finance modeling strategy will provide the most comprehensive
understanding of the term structure of interest rates. We discuss various questions that
arise in this research, and we also present a new examination of the relationship between
two prominent dynamic, latent factor models in this literature: the Nelson-Siegel and affine
no-arbitrage term structure models.
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