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A Kalman filter approach to characterizing the Canadian term structure of interest rates

Author

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  • Toni Gravelle
  • James Morley
Abstract
This paper employs a Kalman filter approach to test the Expectations Hypothesis and characterize how term premia have changed over time for short-term Canadian interest rates. The Kalman filter approach is extended to account for changes in interest rate volatility, possible permanent changes in term premia, and overlapping forecast errors. The Expectations Hypothesis is strongly rejected with estimated term premia displaying significant time variation. There is some evidence of a positive relationship between term premia and interest rate volatility, although other macroeconomic and political factors are important, especially exchange rate volatility. Also, estimated term premia were actually negative during the late 1980s.

Suggested Citation

  • Toni Gravelle & James Morley, 2005. "A Kalman filter approach to characterizing the Canadian term structure of interest rates," Applied Financial Economics, Taylor & Francis Journals, vol. 15(10), pages 691-705.
    • Handle: RePEc:taf:apfiec:v:15:y:2005:i:10:p:691-705
    DOI: 10.1080/09603100500107917
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    Cited by:

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    3. Date, Paresh & Wang, Chieh, 2009. "Linear Gaussian affine term structure models with unobservable factors: Calibration and yield forecasting," European Journal of Operational Research, Elsevier, vol. 195(1), pages 156-166, May.
    4. Date, P. & Canepa, A. & Abdel-Jawad, M., 2011. "A mixed integer linear programming model for optimal sovereign debt issuance," European Journal of Operational Research, Elsevier, vol. 214(3), pages 749-758, November.
    5. K. Triantafyllopoulos, 2007. "Covariance estimation for multivariate conditionally Gaussian dynamic linear models," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 26(8), pages 551-569.
    6. Kopchak, Seth J., 2013. "The realized forward term premium in the repo market," Journal of Financial Markets, Elsevier, vol. 16(2), pages 253-278.
    7. Michael Gordon, 2003. "Estimates of time-varying term premia for New Zealand and Australia," Reserve Bank of New Zealand Discussion Paper Series DP2003/06, Reserve Bank of New Zealand.
    8. Fabrizio Casalin, 2007. "Single Equation Models, Co-Integration and the Expectations Hypothesis of the Term Structure of Interest Rates," Discussion Papers in Economics 07/06, Division of Economics, School of Business, University of Leicester.
    9. Minoas Koukouritakis, 2010. "Structural breaks and the expectations hypothesis of the term structure: evidence from Central European countries," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 145(4), pages 757-774, January.
    10. Minoas Koukouritakis & Leo Michelis, 2008. "The term structure of interest rates in the 12 newest EU countries," Applied Economics, Taylor & Francis Journals, vol. 40(4), pages 479-490.
    11. Casalin, Fabrizio, 2013. "Testing the expectations hypothesis of the term structure with permanent-transitory component models," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 3192-3203.
    12. Long H. Vo, 2014. "Application of Kalman Filter on modelling interest rates," Journal of Management Sciences, Geist Science, Iqra University, Faculty of Business Administration, vol. 1(1), pages 1-15, March.
    13. Arielle Beyaert & Juan Jose Perez-Castejon, 2009. "Markov-switching models, rational expectations and the term structure of interest rates," Applied Economics, Taylor & Francis Journals, vol. 41(3), pages 399-412.

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