The real yield curve and macroeconomic factors in the Chilean economy

Abstract

This article estimates a dynamic model for the yield curve incorporating latent and macro factors to represent the term structure of the real interest rates. The representation of the yield curve is based on the popular latent factor model of Nelson and Siegel (1987), but under a dynamic interpretation due to Diebold and Li (2006). After assuming the data generating process for the latent and macro factors can be represented by a VAR process, the yields-macro model can be regarded as a state-space representation and estimated by a Kalman Filter approach or by using a simplified two-step procedure proposed by Diebold and Li (2006). This article follows the simple two-step method and makes a comparison check with the Kalman Filter estimation, concluding that the basic intuition of the results is not significantly affected by the use of the simplified approach. Estimation results give support to the dynamic interaction between yield curve latent factors and macroeconomic variables. In particular, monetary policy implemented by the Central Bank seems to be influenced by the market players given the significant response of the monetary policy rate to the yield curve factors as shown by impulse-response functions. In addition, the level and slope of the yield curve seems to be responsive to real activity and monetary policy shocks, issues that should be considered by monetary authorities given the dependency of monetary policy effectiveness on the shape of the yield curve.

Notes

¹ This is the negative of the usual slope definition, which is the difference between the long and the short yields.