Taeyoung Doh

What does the yield curve tell us about the Federal Reserve's implicit inflation target?

This paper studies the time variation of the Federal Reserve’s inflation target between 1960 and 2004 using both macro and yield curve data. I estimate a New Keynesian dynamic stochastic general equilibrium model in which the inflation target follows a random-walk process. I compare estimation results obtained from both macroeconomic and yield curve data, two estimates obtained with only macro data, in order to determine what the yield curve tells us about the inflation target. In the joint estimation, the estimated inflation target is much higher during the mid 1980s than in the corresponding macro estimation. Also, some part of the decline in the inflation target during the early or the mid 1980s seems to be perceived as temporary when private agents have to filter out the random walk part of the inflation target from the composite inflation target. My findings suggest that financial market participants were skeptical of the Fed’s commitment to low inflation even after the Volcker disinflation period of the early 1980s.

The state space representation and estimation of a time-varying parameter VAR with stochastic volatility

To capture the evolving relationship between multiple economic variables, time variation in either coefficients or volatility is often incorporated into vector autoregressions (VARs). The state space representation that links the transition of possibly unobserved state variables with observed variables is a useful tool to estimate VARs with time-varying coefficients or stochastic volatility. In this paper, we discuss how to estimate VARs with time-varying coefficients or stochastic volatility using the state space representation. We focus on Bayesian estimation methods which have become popular in the literature. As an illustration of the estimation methodology, we estimate a time-varying parameter VAR with stochastic volatility with the three US macroeconomic variables including inflation, unemployment, and the long-term interest rate. Our empirical analysis suggests that the recession of 2007–2009 was driven by a particularly bad shock to the unemployment rate which increased its trend and volatility substantially. In contrast, the impacts of the recession on the trend and volatility of nominal variables such as the core PCE inflation rate and the 10-year Treasury bond yield are less noticeable.

Yield Curve and Monetary Policy Expectations in Small Open Economies

This paper estimates a New Keynesian dynamic stochastic general equilibrium (DSGE) model in small open economies using the yield curve data as well as standard macro data. The DSGE model is estimated on the data of three inflation-targeting small open economies (Australia, Canada, and New Zealand) using Bayesian methods. We find that the long-end of the yield curve is highly correlated with the current and future short-term interest rates determined by domestic central banks. Yield curve data are particularly informative about the future stance of monetary policy in Australia and Canada in that the correlation between the model-implied monetary policy expectations and the ex-post realized policy interest rates increases when the yield curve data are used in estimation. In New Zealand, estimation results based on only macro data produce a high correlation between the model-implied interest rate expectations and the ex-post realized interest rates because information from the yield curve has been explicitly incorporated in monetary policy decisions. We also document that a persistent shock to the inflation target driving the average level of the yield curve in these three countries is highly correlated with long-horizon inflation expectations in the U.S., indicating stronger financial linkages.

Cash flow and risk premium dynamics in an equilibrium asset-pricing model with recursive preferences

Under linear approximations for asset prices and the assumption of independence between expected consumption growth and time-varying volatility, long-run risks models imply constant market prices of risks and often generate counterfactual results about asset return and cash flow predictability. We develop and estimate a nonlinear equilibrium asset pricing model with recursive preferences and a flexible econometric specification of cash flow processes. While in many long-run risks models time-varying volatility influences only risk premium but not expected cash flows, in our model a common set of risk factors drive both expected cash flow and risk premium dynamics. This feature helps the model to overcome two main criticisms against long-run risk models following Bansal and Yaron (2004): the over-predictability of cash flows by asset prices and the tight relation between time-varying risk premia and growth volatility. Our model extends the approach in Le and Singleton (2010) to a setting with multiple cash flows. We estimate the model using the long-run historical data in the U.S. and find that the model with generalized market prices of risks produces cash flow and return predictability that are more consistent with the data.