Working Paper

An arbitrage-free three-factor term structure model and the recent behavior of long-term yields and distant-horizon forward rates

Abstract: This paper reviews a simple three-factor arbitrage-free term structure model estimated by Federal Reserve Board staff and reports results obtained from fitting this model to U.S. Treasury yields since 1990. The model ascribes a large portion of the decline in long-term yields and distant-horizon forward rates since the middle of 2004 to a fall in term premiums. A variant of the model that incorporates inflation data indicates that about two-thirds of the decline in nominal term premiums owes to a fall in real term premiums, but estimated compensation for inflation risk has diminished as well.

Keywords: Interest rates; Econometric models;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2005

Number: 2005-33