An Affine Model for International Bond Markets
AbstractWe present and estimate a parsimonious multi-factor affine term structure model for joint bond markets. We extend the standard affine models by focusing on joint markets and by incorporating the exchange rate dynamics in the estimation procedure. Estimation is done by means of a Kalman filter algorithm. We find that our particular three factor model is quite successful in fitting bond correlations, both within and between national bond markets. Moreover, the model sheds light on some of the most persistent puzzles in empirical finance. Finally, we apply the model to test for international diversification gains in unhedged bond portfolios, conditional on the information that is present in the term structures of both countries. We find that exchange rate risk is sufficiently priced such that the inclusion of foreign bonds allows for an improved risk-return trade-off from the perspective of a domestic investor.
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Bibliographic InfoPaper provided by Katholieke Universiteit Leuven, Centrum voor Economische Studiën in its series Center for Economic Studies - Discussion papers with number ces0106.
Date of creation: Feb 2001
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Other versions of this item:
- C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models &bull Diffusion Processes
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- Sen Dong, 2006. "Monetary Policy Rules and Exchange Rates:A Structural VAR Identified by No Arbitrage," 2006 Meeting Papers 875, Society for Economic Dynamics.
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