This paper proposes a new term structure model to generalize the Gaussian affine model and the Black model with an efficient and accurate solution method. The new model assumes that arbitrage between money or reserves and government bonds works but not perfectly. The new model enables us to quantify the effects of forward guidance, quantitative easing, and the negative interest rate policy. Estimation results for Switzerland, Germany, and Japan show that the new model outperforms both the Gaussian affine model and the Black model. Moreover, the results indicate that the power of arbitrage moves in tandem with basis swap spreads.
Keywords: Term Structure Model; Monetary Policy; Negative Interest Rate; Basis Swap Spreads
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.