A Type of HJM Based Affine Model: Theory and Empirical Evidence

Haitao Li and Xiaoxia Ye

No 2013-10-14, Working Papers from Wang Yanan Institute for Studies in Economics (WISE), Xiamen University

Abstract: In this paper a type of Heath, Jarrow and Morton (1992) (HJM) based affine model is derived theoretically. This type of affine model is obtained by applying Linear Realization Theory to construct Finite Dimensional Realizations (FDRs) of the Gaussian HJM model. The algorithms of constructing Standard Observable Canonical Realization and Jordan Canonical Realization are introduced sequentially. And it is shown that the commonly adopted FDR is actually Jordan Canonical Realization. The empirical results show that a two-factor model of this type provides great fit to the term structure of interest rates data. The resulting state variables have clear economic interpretations. And it is found that the short end of the term structure can be precisely considered as a “medium-run factor” which uniformly shifts the yield curve. This finding has an important implication for bond portfolios management, and also helps us better understand the interactions between macro-economy and term structure dynamics.

Keywords: Affine Term Structure Model; HJM; Finite Dimensional Realization; Linear Realization Theory; State Space Framework; Macro-economy (search for similar items in EconPapers)
JEL-codes: C61 E43 E44 G12 (search for similar items in EconPapers)
Date: 2013-10-14
New Economics Papers: this item is included in nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:wyi:wpaper:002014

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