Borradores de Economía - A robust model for the term structure of interest rates: some applications in Colombia
La serie Borradores de Economía es una publicación de la Subgerencia de Estudios Económicos del Banco de la República. Los trabajos son de carácter provisional, las opiniones y posibles errores son responsabilidad exclusiva del autor y sus contenidos no comprometen al Banco de la República ni a su Junta Directiva.
The series Borradores de Economía (Working Papers on Economics) contributes to the dissemination and promotion of the work by researchers from the institution. On multiple occasions, these works have been the result of collaborative work with individuals from other national or international institutions. This series is indexed at Research Papers in Economics (RePEc). The opinions contained in this document are the sole responsibility of the author and do not commit Banco de la República or its Board of Directors.
This document presents a Gaussian Affine Term Structure Model (GATSM) of the zero-coupon public debt curve issued locally by the Colombian Government, adopting the methodological approach of Hamilton and Wu (2012) to solve the problems of identification and instability in the estimation of this family of models. Two empirical exercises are presented to highlight the relevance of this methodological approach. The first combines the GATSM structure with a Bayesian Averaging of Classical Estimates (BACE) approach to forecast the yield curve given a set of macroeconomic variables, thus offering a practical way to link a macroeconomic scenario to financial prices in a stress testing exercise. In particular, the document presents the connection with the Systemic Stress Model (SYSMO) of the Financial Stability Department of the Central Bank of Colombia. The second evaluates the effect of monetary policy surprises on sovereign bond yields on a comprehensive set of maturities in a parsimonious way allowed by the GATSM structure. We found an almost immediate, complete, and significant pass-through on the short end of the yield curve. These empirical applications reflect the flexibility of this approach as a tool to address studies that deepen the understanding of the dynamics of yield curves and macroeconomics, the valuation of financial instruments, and financial stability.