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Individual study plan of students of doctoral study at IES
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Student’s data
Name and surname
Aleš Maršál
Year of beginning of studies 2010
Form of studies
Full-time
Advisor’s name
Prof. Ing. Miloslav Vošvrda CSc.
The Term Structure of Interest Rates In Small Open Economy DSGE
Title of dissertation
model
Planned harmonogram of examinations (code/title/semester)
WS 2010 NDES - Nonlinear Dynamic Economic Systems: Theory and Applications
SS 2011 NDES - Nonlinear Dynamic Economic Systems: Theory and Applications
2011/2012
WS: NDES – Nonlinear Dynamic Economic Systems: Theory and Application
SS: NDES – Nonlinear Dynamic Economic Systems: Theory and Application
SS: State Doctoral Exam
2012/2013
WS: NDES – Nonlinear Dynamic Economic Systems: Theory and Application
SS: NDES – Nonlinear Dynamic Economic Systems: Theory and Application
2013/2014
WS: NDES – Nonlinear Dynamic Economic Systems: Theory and Application
WS: Pre-defense
SS: NDES – Nonlinear Dynamic Economic Systems: Theory and Application
SS: Defense
Planned harmonogram of teaching (code/title/semester)
2010/2011
WS: JEM017 Business Cycles Theory
SS: JEM096 Economic dynamics I
2011/2012
WS: JEM017 Business Cycles Theory
SS: JEM096 Economic dynamics I
2012/2013
WS: JEM005 Econometrics A
SS: JEM096 Economic dynamics I
2013/2014
WS: JEM017 Business Cycles Theory
SS: JEM096 Economic dynamics I
Work on dissertation
Synopsis (1- 2 pages)
General introduction
The term structure of interest rates is the key source of information in macroeconomics and finance.
The yield curve has established to be an essential tool in predicting business cycle, it is a fundamental
input in asset pricing and debt management. Since macroeconomics models have had difficulties in
matching real data, estimates of the term structure are usually derived from financial models.
Nevertheless, financial models do not account for monetary policy and macroeconomics fundamentals.
The short term interest rate is the basic building block of the yield curve which is under direct control of
monetary authority. Long interest rates are nothing more than risk adjusted expectations about the
short term interest rates, hence the behavior of the central bank is an important source of information in
determining the shape of the yield curve. In order to better understand the determinants of the yield
curve and improve forecasting robustness of the New Keynesian models and the term structure itself,
the joint macro and finance approach to the term structure of interest rate should be introduced.
Motivation
One way to tackle the issue of understanding the term structure of interest rate in broader framework
is to introduce the term structure into the New Keynesian DSGE model. There has been already
substantial work in this area. To mention several recent papers, for example, Amisano and Tristani
(2008) investigate the DSGE model with yield curve and regime shifts. Rudenbush and Swanson
(2008) points out that introduction of habits in consumption and various market frictions helps to fit the
term structure data but at the cost of distorting the ability of DSGE to fit macro data. Hordahl, Tristani
and Vestin (2005) studies implication of second order approximation and emphasizes the importance of
price rigidities, causing the non-neutrality of monetary policy, in order to match data. Caprioli and
Gnocchi (2009) examine the impact of monetary policy credibility on the yield curve. They conclude that
improvement in monetary policy credibility does not account for the flattening of the yield curve
observed over recent years. Emiris (2006) uses loglinear-lognormal general equilibrium approach to
Smets and Wouters (2003) DSGE model to estimate average premium and reconcile the macro model
with the term structure data.
I would like to extend the research and introduce feedback from the yield curve to macroeconomic
variables. Assuming that agents are forward-looking, their future behavior influences current variables
and therefore, the feedback from the long tail of the yield curve to the equilibrium conditions should be
introduced. The term structure of interest rate is frequently derived from the stochastic discount factor.
After specifying a time-series process for pricing kernel
Q_{t,t+1}=βE_{t}((u′(c_{t+1}))/(u′(c_{t})))((P_{t})/(P_{t+1})) one can find the price of any bond by
chaining together the stochastic discount factors and finding P_{t}ⁿ=E_{t}(Q_{t,t+1}Q_{t+1,t+2}...Q_{t+n1,t+n}). However, after deriving the yield curve agents take into account the bond prices of various
maturities in their decision process. Bond prices contain expectations about the future dynamics of the
economy and with forward-looking agents, these expectations are important determinants of future and
current macroeconomic variables. For instance, log-linearized dynamic IS equation in NK DSGE
models (Gali 2008) usually looks as follows x_{t}=E_{t}x_{t+1}-(1/σ)[i_{t}-E_{t}π_{t+1}-r_{t}ⁿ]. This
equation says that output gap depends on expected next period output gap, expected inflation, current
interest rate and natural rate of interest. Nevertheless, it is intuitive that the expected output gap is a
function of future expected interest rates and thus bond prices with longer maturities. Hence, the
current output gap should depend on the future expected interest rates, therefore on the slope and level
of the term structure of interest rate.
Yet, to set up the model in such way that IS equation contains yield curve is not a trivial exercise and
not much of research in the are has been done yet. I believe that in the timescale of the PhD program I
can investigate the proper setup of the model and contribute to the general research of DSGE models.
During the first year of the PhD program I plan to extend my knowledge of quantitative methods and
familiarize myself extensively with the related research, so that I am able to produce worthwhile draft of
the paper during the second year.
I propose to use standard DSGE NK model with habits in consumptions, various rigidities and
imperfections on the markets where representative agents take into account the term structure of
interest rate in their decision process. Interesting exercise is also to open the model and analyze
behavior of the term structure in small open economy model. The long term interest rates can be
derived from the equilibrium prices of one period state contingent bond on the complete financial
market. However, my previous research of the small open economy model, namely my master thesis,
showed that incomplete financial markets seems to match the moments of macro and financial data.
Basic literature
Bergin, P. R. and Tchakarov, I. (2003). Does exchange rate risk matter for
welfare? NBER Working Paper No. W9900.
Caprioli, F. and Gnocchi, S. (2009). Monetary policy credibility and the term
structure. Universitat Autonoma de Barcelona.
Cochrane, J. H. (2001). Asset pricing. Princeton University Press.
Colantoni, L. (2010). Exchange rate variability in the small open economy with
currency substitution. Bocconi University.
De-Paoli, B. (2006). Monetary policy and welfare in a small open economcy.
CEP Discussion Paper No 639.
Emiris, M. (2006). The term structure of interest rates. Working paper research.
Gal__, J. (2002). Monetary policy and exchange rate volatility in a small open
economy. NBER Working Paper.
Hordahl, P., Tristani, O., and Vestin, D. (2007). The yield curve and macroeconomic dynamics. Working paper series 832.
Julliard, M. (2010). A program for simulating and Eestimating DSGE models.
Monacelli, T. (2003). Monetary policy in a low pass-through enviroment. European Central Bank, Working Paper No, 227. European Central Bank,
Working Paper No, 227.
Natalucci, F. M. and Ravenna, F. (2002). The road to adoptiong the euro:
Monetary policy and exchange rate regimes in eu candidate countries. INternational Finance Discussion Papers.
Obstfeld, M. and Rogo_, K. (1994). Exchange rate dynamics redux. NBER
Working Paper No. 4693.
Rotemberg, J. (1982). Sticky prices in the united states. Journal of Political
Economy.
Schmitt-Grohe, S. and Uribe, M. (2004). Solving dynamic general equilibrium
models using a second-order approximation to the policy function. Journal
of Economic Dynamics and Control.
Stock, J. and Watson, M. (2000). Has the business cycle changed and why.
NBER WP 9127.
Sutherland, A. (2006). The expenditure switching e_ect, welfare and monetary policy in a small open economy. Journal of Economic Dynamics and
Control.
Uribe, M. (May 4, 2009). Lectures in open economy macroeconomics. available
on-line.
Harmonogram of works
2010/2011
Devoting most of the time to research and development of my quantitative skills, some teaching activity
2011/2012
Publishing and teaching
2012/2013
State exam
2013/2014
Submitting dissertation
Planned publication of results
2010/2011 Submitting paper on Term structure of interest rates in Small Open Economy Model to
journal with impact factor, probably in Journal of Economics and Finance and IES WP
2011/2012
Submitting paper on the efficiency of market making algorithms in the Continuous double auction both
to IES WP and Physica A
2012/2013
Submitting paper on Term structure of interest rates in Small Open Economy Model to IES WP. In case
of very good evaluation from thereferee, from IES WP, the paper will be submitted to Journal of
Economic Dynamics and Control
2013/2014
Submitting paper on Endogenous Modeling of the Term Structure of Interest rates in New Keynesian
DSGE model to IES WP. In case of very good evaluation from thereferee, from IES WP, the paper will
be submitted to Journal of Economic Dynamics and Control.
Concretization of study plan for 1st year of study
Teaching
Participation at doctoral seminars
Beginning of work on dissertation
Planned examinations
Other activities
TEACHING
WS: JEM017 Business Cycles Theory
SS: JEM096 Economic dynamics I
PARTICIPATION AT DOCTORAL SEMINARS
WS 2010 NDES - Nonlinear Dynamic Economic Systems: Theory and Applications
SS 2011 NDES - Nonlinear Dynamic Economic Systems: Theory and Applications
Beginning of work on dissertation
Replication of the paper by Hordahl, P., Tristani, O., and Vestin, D. (2007). The yield curve and
macroeconomic dynamics. Working paper series 832 in order to master the technique used in their
research so that I can use the methodology in my research
OTHER ACTIVITIES
WS: Presenting my paper at Euro Working Group at Financial Modeling
SS: Participating at the conference Alpbach 2011
WS and SS: Participation at defenses (at least 50%)
Advisor’s evaluation
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Advisor’s signature
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Student’s signature