Modeling volatility in dynamic term structure models

Hitesh Doshi, Kris Jacobs and Rui Liu

Journal of Financial Economics, 2024, vol. 161, issue C

Abstract: We propose no-arbitrage term structure models with volatility factors that follow GARCH processes. The models’ tractability is similar to canonical affine term structure models, but they fit yield volatility much better, especially for long-maturity yields. This improvement does not come at the expense of a deterioration in yield fit. Because of the improved volatility fit, the model performs substantially better in pricing Treasury futures options. We conclude that the specification of the volatility factors is critical. Modeling volatility as a function of (lagged) squared innovations to factors improves on models where volatility is a linear function of the factors.

Keywords: Term structure; Affine models; Stochastic volatility; GARCH; Treasury futures options (search for similar items in EconPapers)
JEL-codes: C58 E43 G12 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0304405X24001491
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:161:y:2024:i:c:s0304405x24001491

DOI: 10.1016/j.jfineco.2024.103926

Access Statistics for this article

Journal of Financial Economics is currently edited by G. William Schwert

More articles in Journal of Financial Economics from Elsevier
Bibliographic data for series maintained by Catherine Liu ().