The term structure of interest rates and the macroeconomy: Learning about economic dynamics from a FAVAR

Expectations about macroeconomic developments are important determinants of long term interest rates. In this paper, I compare two different assumptions on how agents may form their expectations about the economy and yields in a pseudo real time exercise. Based on the no-arbitrage factor-augmented vector autoregression model developed by Moench (2008), I apply a purely econometric learning scheme as proposed by Laubach, Tetlow, and Williams (2007) in the estimation and compare the results to those of an estimation without discounting. In- and out-of-sample performance indicates that the agents are more inclined to form their expectations according to the learning approach.