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Short-term spot rate models with nonparametric deterministic drift

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  • Al-Zoubi, Haitham A.

Abstract

Most studies assume stationarity when testing continuous-time interest-rate models. However, consistent with Bierens [Bierens, H. (1997). Testing the unit root with drift hypothesis against nonlinear trend stationary, with an application to the US price level and interest rate. Journal of Econometrics, 81, 29-64; Bierens, H. (2000). Nonparametric nonlinear co-trending analysis, with an application to interest and inflation in the United States. Journal of Business and Economics Statistics, 18, 323-337], our nonparametric test results support nonlinear trend stationarity. To accommodate nonstationarity, we detrend the interest-rate series and re-examine a variety of continuous-time models. The goodness-of-fit improves significantly for those models with drift-induced mean reversion and worsens for those with high volatility elasticity. The inclusion of a nonparametric trend component in the drift significantly reduces the level effect on the interest-rate volatility. These results suggest that the misspecification of the constant elasticity model should be attributed to the nonlinear trend component of the short-term interest-rate process.

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Bibliographic Info

Article provided by Elsevier in its journal The Quarterly Review of Economics and Finance.

Volume (Year): 49 (2009)
Issue (Month): 3 (August)
Pages: 731-747

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Handle: RePEc:eee:quaeco:v:49:y:2009:i:3:p:731-747

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Web page: http://www.elsevier.com/locate/inca/620167

Related research

Keywords: Generalized method of moment Nonlinear trend component Spectral kernel;

References

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