Bond Pricing, Monetary Policy and Interest Rate Dynamics

Dr. Burton Hollifield is Professor of Financial Economics at the Tepper School of Business at Carnegie Mellon University. He has been at Carnegie Mellon University since 1998.  Prior to this time, he was Assistant Professor of Finance at University of British Columbia.
Professor Hollifield’s research focuses on market microstructure, asset pricing, portfolio theory, and empirical methods.  His current work focuses on the behavior of intermediaries in the subprime mortgage mortgage and the effects of the Federal Reserve on the term structure of interest rates. He is an associate editor of a number of leading finance journals.  He holds a Ph.D in Financial Economics from Carnegie Mellon University.

Presentation Summary:

This presentation explores the bond-pricing implications of a monetary policy Taylor rule on inflation, interest rate dynamics and Treasury bond returns. The Taylor rule determines inflation and nominal term premiums. A calibrated version of the model matches the observed term structure of both the mean and volatility of yields. In addition, a Taylor rule that matches the properties of observed inflation creates nominal term premiums that remain volatile even at long maturities.

Experiments with different parameter values for the Taylor rule demonstrate that the nominal term premiums can be highly sensitive to monetary policy, and that the recent decrease in the level and volatility of the nominal yields could be the result of a more aggressive monetary policy.

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