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Observational equivalence of discrete string models and market models

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Author Info
Kerkhof, J.
Pelsser, A. (Tilburg University, Center for Economic Research)

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Abstract

In this paper we show that, contrary to the claim made in Longsta, Santa-Clara, and Schwartz (2001a) and Longsta, Santa-Clara, and Schwartz (2001b), discrete string models are not more parsimonious than market models. In fact, they are found to be observationally equivalent. We derive that, for the estimation of both a K-factor discrete string model and a K-factor Libor market model for N forward rates the number of parameters that needs to be estimated equals NK .K (K .1) /2 and not K (K +1)/2 and NK, respectively.

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Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 28.

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Date of creation: 2002
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Handle: RePEc:dgr:kubcen:200228

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Related research
Keywords: string model; market model;

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Goldstein, Robert S, 2000. "The Term Structure of Interest Rates as a Random Field," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 13(2), pages 365-84.
  2. Farshid Jamshidian, 1997. "LIBOR and swap market models and measures (*)," Finance and Stochastics, Springer, vol. 1(4), pages 293-330. [Downloadable!] (restricted)
  3. Santa-Clara, Pedro & Sornette, Didier, 2001. "The Dynamics of the Forward Interest Rate Curve with Stochastic String Shocks," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 14(1), pages 149-85.
  4. Longstaff, Francis A. & Santa-Clara, Pedro & Schwartz, Eduardo S., 2001. "Throwing away a billion dollars: the cost of suboptimal exercise strategies in the swaptions market," Journal of Financial Economics, Elsevier, vol. 62(1), pages 39-66, October. [Downloadable!] (restricted)
  5. Miltersen, K. & K. Sandmann & D. Sondermann, 1994. "Closed Form Solutions for Term Structure Derivatives with Log-Normal Interest Rates," Discussion Paper Serie B 308, University of Bonn, Germany. [Downloadable!]
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