An Admissible Macro-Finance Model of the US Treasury Market

Spencer, Peter

Volume 13, Numbers 1 & 2 / March/June , Pages 1-154

Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 1-38

Peter Spencer , University of York, U.K. Corresponding Author

Abstract:
This paper develops a macro-finance model of the yield curve and uses this to explain the behavior of the US Treasury market. Unlike previous macro-finance models which assume a homoscedastic error process and suppose that the one-period return is directly observable, I develop a general affine model which relaxes these assumptions. My empirical specification uses a single conditioning factor and is thus the macro-finance analogue of the EA1(N) specification of the mainstream finance literature. This model provides a decisive rejection of the standard EA0(N) macro-finance specification. The resulting specification provides a flexible 10-factor explanation of the behavior of the US yield curve, keying it in to the behavior of the macroeconomy.

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