EXPLAINING THE FORWARD INTEREST RATE TERM STRUCTURE

Andrew Matacz () and Jean-Philippe Bouchaud ()
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Andrew Matacz: Science and Finance, 109-111 rue Victor Hugo, 92532 Levallois, France
Jean-Philippe Bouchaud: Service de Physique de l'Etat Condensé CEA-Saclay, Orme des Merisiers, 91 191 Gif s/ Yvette, France

International Journal of Theoretical and Applied Finance (IJTAF), 2000, vol. 03, issue 03, 381-389

Abstract: We present compelling empirical evidence for a new interpretation of the Forward Rate Curve (FRC) term structure. We find that the average FRC follows a square-root law, with a prefactor related to the spot volatility, suggesting a Value-at-Risk like pricing. We find a striking correlation between the instantaneous FRC and the past spot trend over a certain time horizon. This confirms the idea of an anticipated trend mechanism proposed earlier and provides a natural explanation for the observed shape of the FRC volatility. We find that the one-factor Gaussian Heath–Jarrow–Morton model calibrated to the empirical volatility function fails to adequately describe these features.

Date: 2000
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DOI: 10.1142/S0219024900000243

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