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Tractable Term Structure Models

Anh Le, Bruno Feunou (), Christian Lundblad and Jean-Sebastien Fontaine ()

Staff Working Papers from Bank of Canada

Abstract: We introduce a new framework that facilitates term structure modeling with both positive interest rates and flexible time-series dynamics but that is also tractable, meaning amenable to quick and robust estimation. Using both simulations and U.S. historical data, we compare our approach with benchmark Gaussian and stochastic volatility models as well as a shadow rate model that enforces positive interest rates. Our approach, which remains arbitrarily close to arbitrage-free, offers a more accurate characterization of bond Sharpe ratios due to a better fit of the volatility dynamics and a more efficient estimation of the return dynamics. Further, standard shadow rate and stochastic volatility models exhibit important restrictions that are largely absent in our approach.

Keywords: Asset Pricing; Interest rates; International financial markets; International topics; Transmission of monetary policy; Uncertainty and monetary policy (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Pages: 57 pages
Date: 2015
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Handle: RePEc:bca:bocawp:15-46