Interest Rates and Aggregate Life Cycle Determinants

Understanding the persistent trends in interest rates is a theoretical and empirical challenge. This paper links yield curve dynamics with a functional demographic age factor under the life-cycle hypothesis and the no-arbitrage assumption in a semiparametric model. By estimating the model using quarterly U.S. data for seven decades, we find a remarkable fit of the yield curve with countercyclical risk premia and more accurate out-of-sample yield forecasts than alternative models. Our model not only robustly explains the trend in yields with aggregate life cycle determinants, but also efficiently uses the yield curve to infer the S-shaped age impact function.