Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification test for Affine Term Structure Models
Torben Andersen and
No 12962, NBER Working Papers from National Bureau of Economic Research, Inc
We investigate whether bonds span the volatility risk in the U.S. Treasury market, as predicted by most 'affine' term structure models. To this end, we construct powerful and model-free empirical measures of the quadratic yield variation for a cross-section of fixed-maturity zero-coupon bonds ("realized yield volatility") through the use of high-frequency data. We find that the yield curve fails to span yield volatility, as the systematic volatility factors are largely unrelated to the cross-section of yields. We conclude that a broad class of affine diffusive, Gaussian-quadratic and affine jump-diffusive models is incapable of accommodating the observed yield volatility dynamics. An important implication is that the bond markets per se are incomplete and yield volatility risk cannot be hedged by taking positions solely in the Treasury bond market. We also advocate using the empirical realized yield volatility measures more broadly as a basis for specification testing and (parametric) model selection within the term structure literature.
JEL-codes: C14 C32 G12 (search for similar items in EconPapers)
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Published as Torben G. Andersen & Luca Benzoni, 2010. "Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification Test for Affine Term Structure Models," Journal of Finance, American Finance Association, vol. 65(2), pages 603-653, 04.
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Journal Article: Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification Test for Affine Term Structure Models (2010)
Working Paper: Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification Test for Affine Term Structure Models (2007)
Working Paper: Do bonds span volatility risk in the U.S. Treasury market? a specification test for affine term structure models (2006)
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