Asymmetric short-rate model without lower bound
Frédéric Vrins and
Additional contact information
Frédéric Vrins: Université catholique de Louvain, LIDAM/LFIN, Belgium
Linqi Wang: Université catholique de Louvain, LIDAM/CORE, Belgium
No 2021006, LIDAM Discussion Papers LFIN from Université catholique de Louvain, Louvain Finance (LFIN)
We propose a new short-rate process which appropriately captures the salient features of the negative interest rate environment. The model combines the advantages of the Vasicek and Cox-Ingersoll-Ross (CIR) dynamics: it is flexible, tractable and displays positive skewness without imposing a strict lower bound. In addition, a novel calibration procedure is introduced which focuses on minimizing the Kullback-Leibler (KL) divergence between the model- and market-implied forward rate densities rather than focusing on the minimization of price or volatility discrepancies. A thorough empirical analysis based on cap market quotes shows that our model displays superior performance compared to the Vasicek and CIR models regardless of the calibration method. Our proposed calibration procedure based the KL divergence better captures the entire forward rate distribution compared to competing approaches while maintaining a good fit in terms of pricing and implied volatility errors.
Keywords: Finance; affine short-rate model; negative interest rates; Kullback-Leibler divergence; implied density calibration (search for similar items in EconPapers)
JEL-codes: C52 C61 E43 G12 G13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed
Downloads: (external link)
https://dial.uclouvain.be/pr/boreal/en/object/bore ... tastream/PDF_01/view (application/pdf)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:ajf:louvlf:2021006
Access Statistics for this paper
More papers in LIDAM Discussion Papers LFIN from Université catholique de Louvain, Louvain Finance (LFIN) Voie du Roman Pays 34, 1348 Louvain-la-Neuve (Belgium). Contact information at EDIRC.
Bibliographic data for series maintained by Séverine De Visscher ().