Can Spanned Term Structure Factors Drive Stochastic Yield Volatility?

Jens Christensen, Jose Lopez and Glenn Rudebusch

No 2014-3, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: The ability of the usual factors from empirical arbitrage-free representations of the term structure?that is, spanned factors?to account for interest rate volatility dynamics has been much debated. We examine this issue with a comprehensive set of new arbitrage-free term structure specifications that allow for spanned stochastic volatility to be linked to one or more of the yield curve factors. Using U.S. Treasury yields, we find that much realized stochastic volatility cannot be associated with spanned term structure factors. However, a simulation study reveals that the usual realized volatility metric is misleading when yields contain plausible measurement noise. We argue that other metrics should be used to validate stochastic volatility models.

Keywords: arbitrage-free Nelson-Siegel model; term structure modeling; interest rate risk; model validation (search for similar items in EconPapers)
JEL-codes: C51 C52 E43 G12 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2014-01-16
New Economics Papers: this item is included in nep-mac, nep-ore and nep-sog
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Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedfwp:2014-03

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DOI: 10.24148/wp2014-03

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