Tractable Term Structure Models

Bruno Feunou, Jean-Sébastien Fontaine (), Anh Le () and Christian Lundblad ()
Additional contact information
Jean-Sébastien Fontaine: Bank of Canada, Ottawa, Ontario K1A 0G9, Canada
Anh Le: Smeal College of Business, Pennsylvania State University, University Park, Pennsylvania 16801
Christian Lundblad: Kenan–Flagler Business School, University of North Carolina, Chapel Hill, North Carolina 27599-3490

Management Science, 2022, vol. 68, issue 11, 8411-8429

Abstract: We introduce a new framework that facilitates term structure modeling with both positive interest rates and flexible time series dynamics but that is also tractable, meaning amenable to quick and robust estimation. Using both simulations and U.S. historical data, we compare our approach with benchmark Gaussian and stochastic volatility models as well as a shadow rate model that enforces positive interest rates. Our approach, which remains arbitrarily close to arbitrage free, offers a more accurate characterization of bond Sharpe ratios because of a better fit of the volatility dynamics and a more efficient estimation of the return dynamics. Further, the shadow rate and stochastic volatility models exhibit important restrictions that are largely absent in our approach.

Keywords: term structure; lower bound; no arbitrage; no dominance (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (1)

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http://dx.doi.org/10.1287/mnsc.2021.4214 (application/pdf)

Related works:
Working Paper: Tractable Term Structure Models (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:68:y:2022:i:11:p:8411-8429

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