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A Joint Model for the Term Structure of Interest Rates and Realized Volatility*

Anne Lundgaard

Journal of Financial Econometrics, 2023, vol. 21, issue 4, 1196-1227

Abstract: This paper presents a term structure model for no-arbitrage bond yields and realized bond market volatility. Based on well-known results, realized yield curve covariation is linked to generalized autoregressive conditional heteroskedasticity (GARCH)-type conditional covariation. The model is tractable and its latent state variables can be filtered using an exact algorithm. In an empirical study of U.S. Treasury bond data, the model shows that conditional yield curve covariation is priced in long-term yields. Moreover, the model proves useful for multi-step ahead forecasting of realized covariation. Finally, I use the model to quantify interest-rate risk and risk compensation.

Keywords: interest-rate risk; multivariate GARCH; non-linear Kalman filter; realized covariation; term structure modeling; yield curve covariation (search for similar items in EconPapers)
JEL-codes: C13 C32 G12 (search for similar items in EconPapers)
Date: 2023
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