Description

This paper attempts to provide an economic interpretation of the factors that drive the movements of interest rates of bonds of differe nt maturities in a cont inuous-time no-arbitrage term structure model for Chile. The dynamics of yields in the mode l are explained by two latent factors, namely the instantaneous short rate and its time-varyi ng central tendency. The model estimates suggest that the short end of th e yield curve is mainly driven by changes in first latent factor, while long-term interest rates are mainly explained by the second latent factor. Consequently, when examining movements in the term structure, one should think of at least two forces that hit the economy: te mporary shocks that change short-term and medium-term interest rates by much larger am ounts than long-term interest rates, causing changes in the slope of the yield curve; a nd long-lived innovations wh ich have persistent effects on the level of the yield curve.