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A two-factor model of the German term structure of interest rates

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  • Nuno Cassola
  • Jorge Barros Luis
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    Abstract

    This paper shows that a two-factor constant volatility model provides an adequate description of the dynamics and shape of the German term structure of interest rates from 1972 up to 1998. The model also provides reasonable estimates of the volatility and term premium curves. Following the conjecture that the two factors driving the German term structure of interest rates represent the ex-ante real interest rate and the expected inflation rate, the identification of one factor with expected inflation is discussed. The estimates are obtained using a Kalman filter and a maximum likelihood procedure including in the measurement equation both the yields and their volatilities.

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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

    Volume (Year): 13 (2003)
    Issue (Month): 11 ()
    Pages: 783-806

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    Handle: RePEc:taf:apfiec:v:13:y:2003:i:11:p:783-806

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    1. Jorion, Philippe & Mishkin, Frederic, 1991. "A multicountry comparison of term-structure forecasts at long horizons," Journal of Financial Economics, Elsevier, vol. 29(1), pages 59-80, March.
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    6. David K. Backus & Silverio Foresi & Chris Telmer, . "Discrete time models of bond pricing," GSIA Working Papers 251, Carnegie Mellon University, Tepper School of Business.
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    8. Michael J. Fleming & Eli M Remolona, 1999. "The term structure of announcement effects," BIS Working Papers 71, Bank for International Settlements.
    9. Mishkin, Frederic S., 1991. "A multi-country study of the information in the shorter maturity term structure about future inflation," Journal of International Money and Finance, Elsevier, vol. 10(1), pages 2-22, March.
    10. Jacobs, Mike & Remolona, Eli & Wickens, Michael R, 1998. "What was the Market's View of UK Monetary Policy? Estimating Inflation Risk and Expected Inflation with Indexed Bonds," CEPR Discussion Papers 2022, C.E.P.R. Discussion Papers.
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    12. Robert R. Bliss, 1997. "Movements in the term structure of interest rates," Economic Review, Federal Reserve Bank of Atlanta, issue Q 4, pages 16-33.
    13. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
    14. Geyer, Alois L J & Pichler, Stefan, 1999. "A State-Space Approach to Estimate and Test Multifactor Cox-Ingersoll-Ross Models of the Term Structure," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 22(1), pages 107-30, Spring.
    15. Frederic S. Mishkin, 1991. "The Information in the Longer Maturity Term Structure about Future Inflation," NBER Working Papers 3126, National Bureau of Economic Research, Inc.
    16. Stefan Gerlach, 1995. "The information content of the term structure: evidence for Germany," BIS Working Papers 29, Bank for International Settlements.
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    Cited by:
    1. Lemke, Wolfgang, 2007. "An affine macro-finance term structure model for the euro area," Discussion Paper Series 1: Economic Studies 2007,13, Deutsche Bundesbank, Research Centre.
    2. Ralf Fendel, 2005. "An affine three-factor model of the German term structure of interest rates with macroeconomic content," Applied Financial Economics Letters, Taylor and Francis Journals, vol. 1(3), pages 151-156, May.
    3. Fendel, Ralf, 2004. "Towards a Joint Characterization of Monetary Policy and the Dynamics of the Term Structure of Interest Rates," Discussion Paper Series 1: Economic Studies 2004,24, Deutsche Bundesbank, Research Centre.
    4. Peter Vlaar, 2007. "Term Structure Modeling for Pension Funds:What to do in Practice?," DNB Working Papers 123, Netherlands Central Bank, Research Department.
    5. Fendel, Ralf, 2008. "A Joint Characterization of German Monetary Policy and the Dynamics of the German Term Structure of Interest Rates," Review of Applied Economics, Review of Applied Economics, vol. 4(1-2).
    6. Juneja, Januj, 2014. "Term structure estimation in the presence of autocorrelation," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 119-129.

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