Asymmetric Mean Reversion in European Interest Rates: A Two-factor Model

Gregory Koutmos and George Philippatos

The European Journal of Finance, 2007, vol. 13, issue 8, 741-750

Abstract: This paper tests for asymmetric mean reversion in European short-term interest rates using a combination of the interest rate models introduced by Longstaff and Schwartz (Longstaff, F.A., Schwarts, E.S. (1992) Interest rate volatility and the ferm structure: A two factor general equilibrium model, Journal of Finance, 48, pp. 1259-1282.) and Bali (Bali, T. (2000) Testing the empirical performance of stochastic volatility models of the short-term interest rates, Journal of Financial and Quantitative Analysis, 35, pp. 191-215.). Using weekly rates for France, Germany and the United Kingdom, it is found that short-term rates follow in all instances asymmetric mean reverting processes. Specifically, interest rates exhibit non-stationary behavior following rate increases, but they are strongly mean reverting following rate decreases. The mean reverting component is statistically and economically stronger thus offsetting non-stationarity. Volatility depends on past innovations past volatility and the level of interest rates. With respect to past innovations volatility is asymmetric rising more in response to positive innovations. This is exactly opposite to the asymmetry found in stock returns.

Keywords: Interest rates; asymmetric mean reversion; two-factor model (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (4)

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DOI: 10.1080/13518470701705728

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