Modelling International Bond Markets with Affine Term Structure Models

Georg Mosburger and Paul Schneider ()

Finance from EconWPA

Abstract: This paper investigates the performance of international affine term structure models (ATSMs) that are driven by a mutual set of global state variables. We discuss which mixture of Gaussian and square root processes is best suited for modelling international bond markets. We derive necessary conditions for the correlation and volatility structure of mixture models to accommodate various empirical stylized facts such as the forward premium puzzle and differently shaped yield curves. Using UK-US data we estimate international ATSMs taking into account the joint transition density of yields and exchange rates without assuming normality. We find strong empirical evidence for negatively correlated global factors in international bond markets. Further, the empirical results do not support the existence of local factors in the UK-US setting, suggesting that diversification benefits from holding currency- hedged bond portfolios in these markets are likely to be small. Altogether, we find that mixture models greatly enhance the performance of ATSMs.

Keywords: International affine term structure models; Estimation; Exchange rate; Model Selection (search for similar items in EconPapers)
JEL-codes: C33 E43 F31 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin, nep-fmk, nep-ifn and nep-mac
Date: 2005-09-04
Note: Type of Document - pdf; pages: 51
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:0509003

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