Multifactor Keynesian models of the long-term interest rate

Abstract

ABSTRACT This paper presents multifactor Keynesian models of the long-term interest rate. In recent years, there have been a proliferation of empirical studies based on the Keynesian approach to interest rate modelling. These studies evince the connection between the long-term interest rate and the short-term interest rate. However, standard multifactor models of the long-term interest rate in quantitative finance have not been yet incorporated Keynes’s insights about interest rate dynamics. Keynes’s insights are introduced in two different multifactor models of the long-term interest rate to illustrate how the long-term interest rate relates to the short-term interest rate, after controlling for the central bank’s policy rate, expected inflation, the central bank’s inflation target, volatility in financial markets, and Wiener processes.