Is Nonlinear Drift Implied by the Short-End of the Term Structure?
AbstractNonlinear drift models of the short-rate are estimated using data on the short-end of the term structure, where the cross-sectional relation is obtained by an analytical approximation. We find that (i) nonlinear physical drift is not implied unless it is strongly affected by cross-sectional dimensions of the data; (ii) nonlinear risk-neutral drift that allows for fast mean-reversion for high rates is desirable to explain and predict observed patterns of yield spreads; and (iii) for higher-frequency data from which transitory shocks are removed, (ii) still remains valid although the nonlinearity is somewhat reduced.
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Bibliographic InfoPaper provided by Graduate School of Economics, Hitotsubashi University in its series Discussion Papers with number 2006-08.
Length: 42 p.
Date of creation: Nov 2006
Date of revision:
Short-Rate; Nonlinear Drift; Term Structure; Linear Approximation;
Other versions of this item:
- Hideyuki Takamizawa, 2008. "Is Nonlinear Drift Implied by the Short End of the Term Structure?," Review of Financial Studies, Society for Financial Studies, vol. 21(1), pages 311-346, January.
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- Christiansen, Charlotte, 2010.
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- Charlotte Christiansen, 2008. "Mean Reversion in US and International Short Rates," CREATES Research Papers 2008-47, School of Economics and Management, University of Aarhus.
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- Mario Cerrato & Chia Chun Lo & Konstantinos Skindilias, 2011. "Adaptive continuous time Markov chain approximation model to general jump-diffusions," Working Papers 2011_16, Business School - Economics, University of Glasgow.
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- Song, Zhaogang, 2011. "A martingale approach for testing diffusion models based on infinitesimal operator," Journal of Econometrics, Elsevier, vol. 162(2), pages 189-212, June.
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