New study reveals how term spread regressions can predict interest rate changes.
The paper suggests a new way to test why the term spread doesn't always predict future interest rate changes. By considering the effects of changing risk premiums, the researchers used a model with three hidden factors to analyze interest rate data. They found that by accounting for these risk premiums, term spread regressions can give accurate estimates of future long-term interest rate changes, supporting the idea that the term structure can predict interest rate movements.