Short-term spot rate models with nonparametric deterministic drift

Haitham A. Al-Zoubi ()

The Quarterly Review of Economics and Finance, 2009, vol. 49, issue 3, pages 731-747

Abstract: Most studies assume stationarity when testing continuous-time interest-rate models. However, consistent with Bierens [Bierens, H. (1997). Testing the unit root with drift hypothesis against nonlinear trend stationary, with an application to the US price level and interest rate. Journal of Econometrics, 81, 29-64; Bierens, H. (2000). Nonparametric nonlinear co-trending analysis, with an application to interest and inflation in the United States. Journal of Business and Economics Statistics, 18, 323-337], our nonparametric test results support nonlinear trend stationarity. To accommodate nonstationarity, we detrend the interest-rate series and re-examine a variety of continuous-time models. The goodness-of-fit improves significantly for those models with drift-induced mean reversion and worsens for those with high volatility elasticity. The inclusion of a nonparametric trend component in the drift significantly reduces the level effect on the interest-rate volatility. These results suggest that the misspecification of the constant elasticity model should be attributed to the nonlinear trend component of the short-term interest-rate process.

Keywords: Generalized; method; of; moment; Nonlinear; trend; component; Spectral; kernel (search for similar items in EconPapers)
Date: 2009

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