Estimating the Interest Rate Trend in a Shadow Rate Term Structure Model

Wed, 01 Jan 2025 00:00:00 +0000

This paper proposes a shadow rate no-arbitrage dynamic term structure model (SDTSM) with drifting trends to estimate the long-run trend of the real interest rate using yield curve data from the U.S., U.K., and Germany from January 1972 to April/March 2022. The model combines the shadow rate approach of Wu and Xia (2016) to handle the zero lower bound with the shifting endpoint of Bauer and Rudebusch (2020) to capture low-frequency movements. Interest rate trends in all three countries have declined since the 1990s, with strong co-movement among them. The model provides better yield forecasts than existing models. Term premium estimates from the model are stationary and positively correlated with inflation uncertainty measures, corroborating Wright (2011). Under the convention that all permanent shocks to real interest rates are derived from real shocks, the model’s trend estimate also serves as a measure of the natural rate of real interest.

Yang Han | Macro Paper Warehouse

Estimating the Interest Rate Trend in a Shadow Rate Term Structure Model