Discrete time affine term structure models with squared Gaussian shocks (DTATSM-SGS)

Marco Realdon

Quantitative Finance, 2021, vol. 21, issue 8, 1365-1386

Abstract: The tractability of discrete time affine term structure models (DTATSM) is fully preserved when adding squared Gaussian shocks (SGS) to factor processes. SGS guarantee non-negative factors under parameter restrictions that do not affect market prices of risk. Feller conditions are not needed. Changes of measure can alter the conditional covariance of factors and yields through the flexible second-order Esscher transform. Non-negative factors can be conditionally correlated under the real measure even if they are not under the risk-neutral measure. The empirical evidence from US Treasury yields shows that SGS models tend to predict yields conditional volatility, yields unconditional moments and term premia better than the corresponding autoregressive gamma (AG) models.

Date: 2021
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DOI: 10.1080/14697688.2020.1865558

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