No-Arbitrage Taylor Rules

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  • 1 January 2005
    • preprint
      • Published in RePEc
Abstract
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. (This abstract was borrowed from another version of this item.)

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