Risk Premia and Volatilities in a Nonlinear Term Structure Model*

Quadratic term structure models: theory and evidence

Peter Feldhütter, Christian Heyerdahl-Larsen and Philipp Illeditsch

Review of Finance, 2018, vol. 22, issue 1, 337-380

Abstract: We introduce a reduced-form term structure model with closed-form solutions for yields where the short rate and market prices of risk are nonlinear functions of Gaussian state variables. The nonlinear model with three factors matches the time-variation in expected excess returns and yield volatilities of US Treasury bonds from 1961 to 2014. Yields and their variances depend on only three factors, yet the model exhibits features consistent with Unspanned Risk Premia (URP) and Unspanned Stochastic Volatility (USV).

Keywords: Nonlinear term structure models; Expected excess returns; Stochastic volatility; Unspanned Risk Premia; Unspanned Stochastic Volatility (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (5)

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