Disturbing Extremal Behavior of Spot Rate Dynamics

Turan G. Bali () and Salih Neftci
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Turan G. Bali: City University of New York, USA

ICMA Centre Discussion Papers in Finance from Henley Business School, University of Reading

Abstract: This paper presents a study of extreme interest rate movements in the U.S. Federal Funds market over almost a half century of daily observations from the mid 1950s through the end of 2000. We analyze the fluctuations of the maximal and minimal changes in short term interest rates and test the significance of time-varying paths followed by the mean and volatility of extremes. We formally determine the relevance of introducing trend and serial correlation in the mean, and of incorporating the level and GARCH effects in the volatility of extreme changes in the federal funds rate. The empirical findings indicate the existence of volatility clustering in the standard deviation of extremes, and a significantly positive relationship between the level and the volatility of extremes. The results point to the presence of an autoregressive process in the means of both local maxima and local minima values. The paper proposes a conditional extreme value approach to calculating value at risk by specifying the location and scale parameters of the generalized Pareto distribution as a function of past information. Based on the estimated VaR thresholds, the statistical theory of extremes is found to provide more accurate estimates of the rate of occurrence and the size of extreme observations.

Keywords: extreme value theory; volatility; interest rates; value at risk (search for similar items in EconPapers)
JEL-codes: C13 C22 G12 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2002-01
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Journal Article: Disturbing extremal behavior of spot rate dynamics (2003)
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