Title: A flexible short-rate based four factor arbitrage-free term structure model with an explicit monetary policy rule
Authors: Ken Nyholm - European Central Bank (Germany) [presenting]
Abstract: An arbitrage-free four-factor term structure model is derived which facilitates direct parameterization of the short-term interest rate process. The interplay between macroeconomic variables and the term structure via a monetary policy reaction function is therefore directly supported. We show that the proposed model is a constrained member of the canonical GDTSM family. The model's loading structure closely resembles a previous model, but it relies only on a single nonlinear shape parameter, and it is therefore easy to estimate. An empirical application to US data covering the period from 1961 to 2017 demonstrates that the proposed model fits yields well, and that an embedded policy rule, including industrial production and the inflation rate, is statistically significant and economically meaningful during this time-period.