The term structure of interest rates and macroeconomic factors: Evidence from Indian financial market

Abstract

The term structure of interest rate per-se is not impeccable for explaining the behavior of the future economic conditions and hence incorporating macro factors in the term structure model is more tractable. The study uses monthly data of macro factors for a period of eighteen years from April 1998 to May 2016. Using structural vector auto regression estimates, Granger causality/block exogeneity wald test along with impulse response functions and forecast error variance decomposition analysis the study tests the proportion of term structure attributable to macro-economic shocks. The findings of the study show that short term rates are mainly influenced by the fiscal deficit present in emerging economies while long term rates get affected when market participants revise their expectation on yields. In addition, the output growth of the country is mainly depended on long and short rates and exchange rate fluctuations have a significant role in the fiscal deficit of the country. Keywords: Term structure of interest rates, Inflation, Output growth, NEER, Monetary policy rate, JEL Classification: E43, E31, E2