Title: How learning from macroeconomic experiences shapes the term structure of interest rates
Authors: Kasper Jorgensen - Aarhus University (Denmark) [presenting]
Abstract: Constant-gain learning expectations of consumption growth and inflation capture 81-88 pct of the variation in 1- through 10-year nominal interest rates. The residuals in interest rates from the learning-based factors have a two-factor structure and represent investor sentiment. The four term structure factors predict excess returns with R2's up to 53 pct, and subsume the predictive information in the most popular bond return predictors. We use these four factors to formulate a dynamic term structure model, which implies that short rate expectations account for the trend component of long term interest rates, whereas term premia are more cyclical, compared to the predictions of the workhorse affine term structure model. We also show that the proposed model is consistent with a declining equilibrium real rate over the last two decades.