Modifying Gaussian term structure models when interest rates are near the zero lower bound

Leo Krippner

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

Abstract: With nominal interest rates currently at or near their zero lower bound (ZLB) in many major economies, it has become untenable to apply Gaussian a?ne term structure models (GATSMs) while ignoring their inherent non-zero probabilities of negative interest rates. In this article I modify GATSMs by representing physical currency as call options on bonds to establish the ZLB. The resulting ZLB-GATSM framework remains tractable, producing a simple closed-form analytic expression for forward rates and requiring only elementary univariate numerical integration (over time to maturity) to obtain interest rates and bond prices. I demonstrate the salient features of the ZLB-GATSM framework using a two-factor model. An illustrative application to U.S. term structure data in- dicates that movements in the model state variables have been consistent with unconventional monetary policy easings undertaken after the U.S. policy rate reached the ZLB in late 2008.

JEL-codes: E43 G12 G13 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2011-10
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Related works:
Working Paper: Modifying Gaussian term structure models when interest rates are near the zero lower bound (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:een:camaaa:2011-36

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