Unbiased estimate of dynamic term structure models

Michael Bauer, Glenn Rudebusch and Jing Cynthia Wu

No 2011-12, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: Affine dynamic term structure models (DTSMs) are the standard finance representation of the yield curve. However, the literature on DTSMs has ignored the coefficient bias that plagues estimated autoregressive models of persistent time series. We introduce new simulation-based methods for reducing or even eliminating small-sample bias in empirical affine Gaussian DTSMs. With these methods, we show that conventional estimates of DTSM coefficients are severely biased, which results in misleading estimates of expected future short-term interest rates and long-maturity term premia. Our unbiased DTSM estimates imply risk-neutral rates and term premia that are more plausible from a macro-finance perspective.

Keywords: Interest; rates (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-cba and nep-ecm
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