The Term Structure with Semi‐credible Targeting
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- Author(s): Heber Farnsworth, Richard Bass
- Published: Mar 21, 2003
- Pages: 839-866
- DOI: 10.1111/1540-6261.00548
The Federal Reserve sets targets for interest rates which it enforces through direct market intervention. These targets are changed periodically. In this paper, we develop a term structure model in which the short rate is subject to a control which keeps it close to a target which changes from time to time. The probability of target changes is not constant in the model, but changes as a function of observables. The model performs well at explaining the shifts in the yield curve that accompany target changes.