FEDERAL RESERVE BANK OF SAN FRANCISCO WORKING PAPER SERIES Bayesian Estimation of Dynamic Term Structure Models under Restrictions on Risk Pricing

This paper performs Bayesian estimation of affine Gaussian dynamic term structure models (DTSMs) in which the risk price parameters are restricted. A new econometric framework for DTSM estimation allows the researcher to select plausible constraints from a large set of restrictions, to correctly quantify statistical uncertainty, and to incorporate model uncertainty. The main empirical result is that under the restrictions favored by the data the expectations component, and not the term premium, accounts for the majority of high-frequency movements of long-term interest rates. At lower frequencies, term premia are counter-cyclical and more stable than implied by DTSMs without risk price