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Design and Estimation of Quadratic Term Structure Models

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  • Markus Leippold
  • Liuren Wu

Abstract

We consider the design and estimation of quadratic term structure models. We start with a list of stylized facts on interest rates and interest rate derivatives, classified into three layers: (1) general statistical properties, (2) forecasting relations, and (3) conditional dynamics. We then investigate the implications of each layer of property on model design and strive to establish a mapping between evidence and model structures. We calibrate a two-factor model that approximates these three layers of properties well, and show that a flexible specification for the market price of risk is important in capturing the stylized evidence in forecasting relations while factor interactions are indispensable in generating the hump-shaped dynamics of bond yields. JEL classification codes: G12, G13, E43.

Suggested Citation

  • Markus Leippold & Liuren Wu, 2003. "Design and Estimation of Quadratic Term Structure Models," Review of Finance, European Finance Association, vol. 7(1), pages 47-73.
    • Handle: RePEc:oup:revfin:v:7:y:2003:i:1:p:47-73.
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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