Term Structure Models: A Perspective from the Long Rate

Yong Yao

North American Actuarial Journal, 1999, vol. 3, issue 3, 122-138

Abstract: Term structure models based on dynamic asset-pricing theory are discussed by taking a perspective from the long rate. This paper partially answers two questions about the asymptotic behavior of yields on default-free zero-coupon bonds: in frictionless markets having no arbitrage, what should the behavior be; and, in known term structure models, what can the behavior be.In frictionless markets having no arbitrage, yields of all maturities should be positive and uniformly bounded from above. The yield curve should level out as term to maturity increases. Slopes with large absolute values occur only in the early maturities. In a continuous-time framework, the longer the maturity of the yield is, the less volatile it will be. The long rate should be a nondecreasing process. Furthermore, the long rate in continuous-time factor models with nonsingular volatility matrices should be a nondecreasing deterministic function.In the Black, Derman, and Toy model and factor models with the short rate having the mean reversion property, yields of all maturities are uniformly bounded from above. The long rate in the Duffie and Kan model with the mean reversion property is a constant. The long rate in the Heath, Jarrow, and Morton model can be infinite or a nondecreasing process. Examples with the long rate increasing are given in this paper. A model with the long rate and short rate as two state variables is then obtained.

Date: 1999
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DOI: 10.1080/10920277.1999.10595839

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