No-Arbitrage Taylor Rules
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NBER Working Paper No. 13448
Issued in September 2007
NBER Program(s): AP EFG ME
We estimate Taylor (1993) rules and identify monetary policy shocks using no-arbitrage pricing techniques. Long-term interest rates are risk-adjusted expected values of future short rates and thus provide strong over-identifying restrictions about the policy rule used by the Federal Reserve. The no-arbitrage framework also accommodates backward-looking and forward-looking Taylor rules. We find that inflation and output gap account for over half of the variation of time-varying excess bond returns and most of the movements in the term spread. Taylor rules estimated with no-arbitrage restrictions differ from Taylor rules estimated by OLS, and the resulting monetary policy shocks are somewhat less volatile than their OLS counterparts.
Published: Andrew Ang & Sen Dong & Monika Piazzesi, 2005.
"No-arbitrage Taylor rules,"
Proceedings,
Federal Reserve Bank of San Francisco.
This paper is available as PDF (902 K) or via email.
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