Staying on Top of the Curve: A Cascade Model of Term Structure Dynamics

Laurent Calvet, Adlai Fisher and Liuren Wu

Journal of Financial and Quantitative Analysis, 2018, vol. 53, issue 2, 937-963

Abstract: This paper specifies term structure dynamics by a recursive cascade of heterogeneously persistent factors. The cascade naturally orders economic shocks by their adjustment speeds, and generates smooth interest-rate curves in closed form. For a class of specifications, the number of parameters is invariant to the size of the state space, and the term structure converges to a stochastic limit as the state dimension goes to infinity. High-dimensional specifications fit observed term structure almost perfectly, match the observed low correlation between movements in different maturities, and produce stable interest-rate forecasts that outperform lower-dimensional specifications.

Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:cup:jfinqa:v:53:y:2018:i:02:p:937-963_00

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