(An) interest rate term structure estimation methodology and a business forecast method utilizing the structural changes in the term structure

Abstract

This study examines two main topics on the term structure of interest rates: the estimation of the theoretical term structure curve and the utilization of information on the slope of the term structure for predicting business cycle turning point. Chapter I overviews this study. Chapter II describes a methodology of term structure estimation incorporating callable Treasury bonds using a bond-option valuation model. This chapter also examines whether some simple approximation of the option value suffice for providing a useful estimation procedure. The authors find that the errors in extimating the option value can generate significant errors for estimating the discount function. A call provision on a Treasury bond is not negligible at least within our framework. This procedure is consistent with two aspects of the Treasury market. First, it provides the discount function that best determines the prices of observed Treasury securities, and second, it obtains a discount function that explains callable Treasuries. Chapter III describes a predicition scheme for business cycle turning points by detecting the related level-changes in the term structure of interest rates. We find that, under monetary regime resulting in very stable federal funds rate, change in long-fed spread (long-term Treasuries rate minus federal funds rate) has extra predictive power for economic activity over the level of spread itself within certain forecasting horizon. We also find that, under monetary regime causing very unstable federal funds rate, there is no predictive power in the spread level and change in the spread as well. The predictive power of change in the spread depends highly on the volatility of the funds rate. This chapter introduces a statistical model utilizing the spread chage and its volatility to systematically generate signals for business cycle turning points. In the latest years the variability of the funds rate suggests that it is tantamount to targeting the funds rate ...