The Volatility of the Instantaneous Spot Interest Rate Implied by Arbitrage Pricing - A Dynamic Bayesian Approach

Ram Bhar, Carl Chiarella (), Hing Hung and Wolfgang Runggaldier
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Ram Bhar: School of Banking & Finance, University of New South Wales
Hing Hung: School of Finance & Economics, University of Technology, Sydney
Wolfgang Runggaldier: Dipartimento di Matematica Pura ed Applicata, Universit´a di Padova

Finance from EconWPA

Abstract: This paper considers the estimation of the volatility of the instantaneous short interest rate from a new perspective. Rather than using discretely compounded market rates as a proxy for the instantaneous short rate of interest, we derive a relationship between observed LIBOR rates and certain unobserved instantaneous forward rates. We determine the stochastic dynamics for these rates under the risk- neutral measure and propose a filtering estimation algorithm for a time- discretised version of the resulting interest rate dynamics based on dynamic Bayesian updating. The method is applied to US Treasury rates of various maturities and is found to give a reasonable model fit.

JEL-codes: G (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn, nep-cmp, nep-ets, nep-fin and nep-rmg
Date: 2004-09-01
Note: Type of Document - pdf; pages: 29
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:0409002

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