An affine model of the term structure of interest rates in Mexico

We develop and estimate an affine model that characterizes the dynamics of the term structure of interest rates in Mexico. Moreover, we provide empirical evidence on the relationship between the term structure factors and macroeconomic variables. First, we show that the model fits the data remarkably well. Second, we show that the first factor captures movements in the level of the yield curve, while the second factor captures movements in the slope of the curve. Third, the variance decomposition results show that the level factor accounts for a substantial part of the variance at the long end of the yield curve at all horizons. At short horizons, the slope factor accounts for much of the variance at the short end of the yield curve. Finally, we show that movements in the level of the yield curve are associated with movements in long-term inflation expectations, while movements in the slope of the curve are associated with movements in the short-term nominal interest rate.