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An Evaluation of MLE in a Model of the Nonlinear Continuous-Time Short-Term Interest Rate

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  • Ingrid Lo
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    Abstract

    The author compares the performance of three Gaussian approximation methods--by Nowman (1997), Shoji and Ozaki (1998), and Yu and Phillips (2001)--in estimating a model of the nonlinear continuous-time short-term interest rate. She finds that the performance of Nowman's method is similar to that of Shoji and Ozaki's method, whereas the window width used in the Yu and Phillips method has a critical influence on parameter estimates. When a small window width is used, the Yu and Phillips method does not outperform the other two methods. Choosing a suitable window width can reduce estimation bias quite significantly, whereas too large a window width can worsen estimation bias and the fit of the model. An empirical study is implemented using Canadian and U.K. one-month interest rate data.

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    Bibliographic Info

    Paper provided by Bank of Canada in its series Working Papers with number 05-45.

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    Length: 50 pages
    Date of creation: 2005
    Date of revision:
    Handle: RePEc:bca:bocawp:05-45

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    Related research

    Keywords: Interest rates; Econometric and statistical methods;

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    1. Yacine Aït-Sahalia, 1999. "Transition Densities for Interest Rate and Other Nonlinear Diffusions," Journal of Finance, American Finance Association, vol. 54(4), pages 1361-1395, 08.
    2. 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.
    3. Chan, K C, et al, 1992. " An Empirical Comparison of Alternative Models of the Short-Term Interest Rate," Journal of Finance, American Finance Association, vol. 47(3), pages 1209-27, July.
    4. Michael J. Brennan and Eduardo S. Schwartz., 1979. "A Continuous-Time Approach to the Pricing of Bonds," Research Program in Finance Working Papers 85, University of California at Berkeley.
    5. Nowman, K B, 1997. " Gaussian Estimation of Single-Factor Continuous Time Models of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 52(4), pages 1695-1706, September.
    6. Brennan, Michael J. & Schwartz, Eduardo S., 1979. "A continuous time approach to the pricing of bonds," Journal of Banking & Finance, Elsevier, vol. 3(2), pages 133-155, July.
    7. Singleton, Kenneth J., 2001. "Estimation of affine asset pricing models using the empirical characteristic function," Journal of Econometrics, Elsevier, vol. 102(1), pages 111-141, May.
    8. David A. Chapman & Neil D. Pearson, 1998. "Is the Short Rate Drift Actually Nonlinear?," Finance 9808005, EconWPA.
    9. Jun Yu & Peter C.B. Phillips, 2001. "Gaussian Estimation of Continuous Time Models of the Short Term Interest Rate," Cowles Foundation Discussion Papers 1309, Cowles Foundation for Research in Economics, Yale University.
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