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Continuous time modeling of interest rates: An empirical study on the Turkish short rate

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  • Bayraci, Selcuk
  • UNAL, GAZANFER
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    Abstract

    We proposed a continuous time ARMA known as CARMA(p,q) model for modeling the interest rate dynamics. CARMA(p,q) models have an advantage over their discrete time counterparts that they allow using Ito formulas and provide closed-form solutions for bond and bond option prices. We demonstrate the capabilities of CARMA(p,q) models by using Turkish short rate. The Turkish Republic Central Bank’s benchmark bond prices are used to calculate short-term interest rates between the period of 15.07.2006 and 15.07.2008. ARMA(1,1) model and CARMA(1,0) model are chosen as best suitable models in modeling the Turkish short rate.

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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 28091.

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    Date of creation: 15 Nov 2010
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    Handle: RePEc:pra:mprapa:28091

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    Keywords: Interest rate modeling; Continuous-time ARMA (CARMA)process; Lévy process;

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    1. 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.
    2. Andersen, Torben G. & Lund, Jesper, 1997. "Estimating continuous-time stochastic volatility models of the short-term interest rate," Journal of Econometrics, Elsevier, vol. 77(2), pages 343-377, April.
    3. Ait-Sahalia, Yacine, 1996. "Testing Continuous-Time Models of the Spot Interest Rate," Review of Financial Studies, Society for Financial Studies, vol. 9(2), pages 385-426.
    4. 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.
    5. Yongmiao Hong & Haitao Li & Feng Zhao, 2004. "Out-of-Sample Performance of Discrete-Time Spot Interest Rate Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 22, pages 457-473, October.
    6. Gray, Stephen F., 1996. "Modeling the conditional distribution of interest rates as a regime-switching process," Journal of Financial Economics, Elsevier, vol. 42(1), pages 27-62, September.
    7. David A. Chapman & Neil D. Pearson, 2000. "Is the Short Rate Drift Actually Nonlinear?," Journal of Finance, American Finance Association, vol. 55(1), pages 355-388, 02.
    8. Pritsker, Matt, 1998. "Nonparametric Density Estimation and Tests of Continuous Time Interest Rate Models," Review of Financial Studies, Society for Financial Studies, vol. 11(3), pages 449-87.
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