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Pricing the term structure with linear regressions

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  • Adrian, Tobias
  • Crump, Richard K.
  • Moench, Emanuel

Abstract

We show how to price the time series and cross section of the term structure of interest rates using a three-step linear regression approach. Our method allows computationally fast estimation of term structure models with a large number of pricing factors. We present specification tests favoring a model using five principal components of yields as factors. We demonstrate that this model outperforms the Cochrane and Piazzesi (2008) four-factor specification in out-of-sample exercises but generates similar in-sample term premium dynamics. Our regression approach can also incorporate unspanned factors and allows estimation of term structure models without observing a zero-coupon yield curve.

Suggested Citation

  • Adrian, Tobias & Crump, Richard K. & Moench, Emanuel, 2013. "Pricing the term structure with linear regressions," Journal of Financial Economics, Elsevier, vol. 110(1), pages 110-138.
    • Handle: RePEc:eee:jfinec:v:110:y:2013:i:1:p:110-138
    DOI: 10.1016/j.jfineco.2013.04.009
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    More about this item

    Keywords

    Term structure of interest rates; Fama-MacBeth regressions; Dynamic asset pricing estimation; Empirical finance;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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