UK Macroeconomic Volatility and the Term Structure of Interest Rates

This study uses a macro-finance model to examine the ability of the gilt market to predict fluctuations in macroeconomic volatility. The econometric model is a development of the standard square root' volatility model, but unlike the conventional term structure specification it allows for separate volatility and inflation trends. It finds that although volatility and inflation trends move independently in the short run, they are cointegrated. Bond yields provide useful information about macroeconomic volatility, but a better indicator can be developed by combining this with macroeconomic information.