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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.

The Recent Shift in Term Structure Behavior from a No-arbitrage Macro-finance Perspective