USV-Affine Models Without Derivatives: A Bayesian Time-Series Approach

Malefane Molibeli () and Gary van Vuuren
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Malefane Molibeli: School of Economics and Finance, University of the Witwatersrand, Johannesburg 2000, South Africa
Gary van Vuuren: Centre for Business Mathematics and Informatics, North-West University, Potchefstroom Campus, Potchefstroom 2520, South Africa

JRFM, 2025, vol. 18, issue 7, 1-36

Abstract: We investigate the affine term structure models (ATSMs) with unspanned stochastic volatility (USV). Our aim is to test their ability to generate accurate cross-sectional behavior and time-series dynamics of bond yields. Comparing the restricted models and those with USV, we test whether they produce both reasonable estimates for the short rate variance and cross-sectional fit. Essentially, a joint approach from both time series and options data for estimating risk-neutral dynamics in ATSMs should be followed. Due to the scarcity of derivative data in emerging markets, we estimate the model using only time-series of bond yields. A Bayesian estimation approach combining Markov Chain Monte Carlo (MCMC) and the Kalman filter is employed to recover the model parameters and filter out latent state variables. We further incorporate macro-economic indicators and GARCH-based volatility as external validation of the filtered latent volatility process. The A 1 ( 4 ) USV performs better both in and out of sample, even though the issue of a tension between time series and cross-section remains unresolved. Our findings suggest that even without derivative instruments, it is possible to identify and interpret risk-neutral dynamics and volatility risk using observable time-series data.

Keywords: parameter and model identifiability; stochastic volatility; MCMC; unspanned stochastic volatility (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2025
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