The Indonesian macroeconomy and the yield curve: A dynamic latent factor approach |
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| Affiliation: | 1. Department of Economics, Southern Illinois University, Edwardsville, IL 62026-1102, USA;2. Department of Economics, University of Texas at San Antonio, San Antonio, TX 78249-0633, USA;1. University of Adelaide, Australia;2. The Johns Hopkins University Bologna Center, Italy;1. Department of Economics and Geography, Coggin College of Business, University of North Florida, Jacksonville, FL 32224, United States;2. Department of Economics, California State University, Fresno, United States;3. Reliant Energy, 1201 Fannin Street, Houston, TX 77002, United States;1. Division of Economics, Hankuk University of Foreign Studies, Republic of Korea;2. Department of Economics, Sungkyunkwan University, Republic of Korea;1. School of Economics and Finance, Curtin Business School, Australia;2. School of Business & Law, Edith Cowan University, Australia |
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| Abstract: | We develop a fine representation of the term structure of interest rates in Indonesia and create a link between the yield curve and macroeconomic fundamentals. We construct a state-space representation of the yield curve as a function of three time-varying parameters: level, slope, and curvature factors. The model is then expanded to include three macroeconomic variables: real activity, inflation, and interest rates. We find that the dynamic latent factor model provides a very good fit to characterise the Indonesian yield curve in terms of the statistical properties for each maturity, and in terms of the properties of three latent yield-curve factors. With regards to the relationship to the macroeconomy, we find that there is a large amount of idiosyncratic variation in the yield curve movements. Therefore, macroeconomic variables can only explain small dynamics in the yield curve. |
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| Keywords: | Yield curve Interest rates Factor model State-space model |
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