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A Macroeconomic Model of the Term Structure of Interest Rates in Mexico.

By Josué Fernando Cortés Espada and Manuel Ramos Francia

Abstract

This paper investigates how different macroeconomic shocks affect the term-structure of interest rates in Mexico. In particular, we develop a model that combines a no-arbitrage specification of the term structure with a macroeconomic model of a small open economy. We find that shocks that are perceived to have a persistent effect on inflation affect the level of the yield curve. The effect on medium and long-term yields results from the increase in expected future short rates and in risk premia. With respect to demand shocks, our results show that a positive shock leads to an upward flattening shift in the yield curve. The flattening of the curve is explained by both the monetary policy response and the time-varying term premia.Term-Structure, No-Arbitrage, Macroeconomic Shocks.

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