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A Joint Model for the Term Structure of Interest Rates and Realized Volatility

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  • Anne Lundgaard

Abstract

This paper presents a term structure model for no-arbitrage bond yields and realized bond market volatility. Based on well-known results, realized yield curve covariation is linked to generalized autoregressive conditional heteroskedasticity (GARCH)-type conditional covariation. The model is tractable and its latent state variables can be filtered using an exact algorithm. In an empirical study of U.S. Treasury bond data, the model shows that conditional yield curve covariation is priced in long-term yields. Moreover, the model proves useful for multi-step ahead forecasting of realized covariation. Finally, I use the model to quantify interest-rate risk and risk compensation.

Suggested Citation

  • Anne Lundgaard, 2023. "A Joint Model for the Term Structure of Interest Rates and Realized Volatility," Journal of Financial Econometrics, Oxford University Press, vol. 21(4), pages 1196-1227.
    • Handle: RePEc:oup:jfinec:v:21:y:2023:i:4:p:1196-1227.
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nbac001
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    More about this item

    Keywords

    interest-rate risk; multivariate GARCH; non-linear Kalman filter; realized covariation; term structure modeling; yield curve covariation;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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