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The Statistical and Economic Role of Jumps in Continuous-Time Interest Rate Models

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Michael Johannes
Abstract

This paper analyzes the role of jumps in continuous-time short rate models. I first develop a test to detect jump-induced misspecification and, using Treasury bill rates, find evidence for the presence of jumps. Second, I specify and estimate a nonparametric jump-diffusion model. Results indicate that jumps play an important statistical role. Estimates of jump times and sizes indicate that unexpected news about the macroeconomy generates the jumps. Finally, I investigate the pricing implications of jumps. Jumps generally have a minor impact on yields, but they are important for pricing interest rate options. Copyright 2004 by The American Finance Association.

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Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 59 (2004)
Issue (Month): 1 (02)
Pages: 227-260
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Handle: RePEc:bla:jfinan:v:59:y:2004:i:1:p:227-260

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  10. Daal, Elton, 2004. "Quadratic term structure models with jumps in incomplete currency markets," Working Papers 2004-04, University of New Orleans, Department of Economics and Finance. [Downloadable!]
  11. J. Benson Durham, 2005. "Jump-diffusion processes and affine term structure models: additional closed-form approximate solutions, distributional assumptions for jumps, and parameter estimates," Finance and Economics Discussion Series 2005-53, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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