The Canadian Macroeconomy and the Yield Curve: An Equilibrium-Based Approach

23 Pages Posted: 19 May 2007

See all articles by Richard Luger

Richard Luger

Emory University - Department of Economics

René Garcia

Université de Montréal - CIREQ - Département de sciences économiques; University of Montreal

Abstract

The authors develop and estimate an equilibrium-based model of the Canadian term structure of interest rates. The proposed model incorporates a vector-autoregression description of key macroeconomic dynamics and links them to those of the term structure, where identifying restrictions are based on the first-order conditions that describe the representative investor's optimal consumption and portfolio plan. A remarkable result is that the in-sample average pricing errors obtained with the equilibrium-based model are only slightly larger than those obtained with a far more flexible no-arbitrage model. The gains associated with parsimony become obvious out-of-sample, where the equilibrium model delivers much more accurate predictions, especially for yields with longer-term maturities. The preferred equilibrium model has impulse responses that are consistent with long-term inflation expectations being anchored, so a surprise increase in inflation does not necessarily raise expectations of higher future inflation.

Suggested Citation

Luger, Richard and Garcia, René, The Canadian Macroeconomy and the Yield Curve: An Equilibrium-Based Approach. Canadian Journal of Economics, Vol. 40, No. 2, pp. 561-583, May 2007, Available at SSRN: https://ssrn.com/abstract=986760 or http://dx.doi.org/10.1111/j.1540-5982.2007.00421.x

Richard Luger

Emory University - Department of Economics ( email )

1602 Fishburne Drive
Atlanta, GA 30322
United States
404-727-0328 (Phone)
404-727-4639 (Fax)

René Garcia (Contact Author)

Université de Montréal - CIREQ - Département de sciences économiques ( email )

C.P. 6128, succursale Centre-Ville
3150, rue Jean-Brillant, bureau C-6027
Montreal, Quebec H3C 3J7
Canada
514-985-4014 (Phone)

University of Montreal ( email )

United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
16
Abstract Views
540
PlumX Metrics