A term structure model with level factor cannot be realistic and arbitrage free

Simon Dubecq () and Christian Gourieroux

Working papers from Banque de France

Abstract: A large part of the term structure literature interprets the first underlying factors as a level factor, a slope factor, and a curvature factor. In this paper we consider factor models interpretable as a level factor model, a level and a slope factor model, respectively. We prove that such models are compatible with no-arbitrage restrictions and the positivity of rates either under rather unrealistic conditions on the dynamic of the short term interest rate, or at the cost of explosive long-term interest rates. This introduces some doubt on the relevance of the level and slope interpretations of factors in term structure models.

Keywords: Interest Rate; Term Structure; Affine Model; No Arbitrage; Level Factor; Slope Factor. (search for similar items in EconPapers)
JEL-codes: E43 E44 G12 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2012
New Economics Papers: this item is included in nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:359

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