Evolving macroeconomic perceptions and the term structure of interest rates

We explore the role of evolving beliefs regarding the structure of the macroeconomy in improving our understanding of the term structure of interest rates within the context of a simple macro-finance model. Using quarterly vintages of real-time data and survey forecasts for the United States over the past 40 years, we show that a recursively estimated VAR on real GDP growth, inflation and the nominal short-term interest rate generates predictions that are more consistent with survey forecasts than a benchmark fixed-coefficient counterpart. We then estimate a simple term structure model under the assumption that investor risk attitude is driven by near-term expectations of the three state variables. When we allow for evolving beliefs about the macroeconomy, the resulting term structure model provides a better fit to the cross section of yields than the benchmark model, especially at longer maturities, and exhibits better performance in out-of-sample predictions of future yield movements.