The recent shift in term structure behavior from a no-arbitrage macro-finance perspective

This paper examines a recent shift in the dynamics of the term structure and interest rate risk. We first use standard yield-spread regressions to document such a shift in the U.S. in the mid-1980s. Over the pre- and post-shift subsamples, we then estimate dynamic, affine, no-arbitrage models, which exhibit a significant difference in behavior that can be largely attributed to changes over time in the pricing of risk associated with a “level” factor. Finally, we suggest a link between the shift in term structure behavior and changes in the risk and dynamics of the inflation target as perceived by investors.