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Nonparametric Estimation of Multifactor Continuous Time Interest-Rate Models

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Author Info
Christopher T. Downing () (Board of Governors, Federal Reserve)
Abstract

In this paper we study the finite sample properties of the nonparametric method developed by Stanton and later extended by Boudoukh, et al. for the estimation of the drifts and diffusions of multifactor continuous-time term-structure models. Monte Carlo simulations from a known parametric model are employed to calculate the performance of the estimator. The paper focuses on the issue of optimal bandwidth selection. The results suggest that, for persistent data-generating processes exhibiting stochastic volatility, such as interest rate data, a bandwidth function that varies over the surface of the data is optimal. The paper also presents a computationally intensive bandwidth-selection procedure that uses dynamic graphics, combining the computational power of the machine with the pattern-recognition abilities of the human brain. The Monte Carlo simulations require the numeric solution of a system of stochastic differential equations. The paper also presents a nonparametric test for the validity of the solutions. This test is useful in other estimation algorithms, such as the efficient method of moments, where numeric solutions of stochastic differential equations are required. The test is also useful as a tool for understanding how the length of the time step used in the numeric solution of the stochastic differential solutions affects the accuracy of the solution.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 1999 with number 111.

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Date of creation: 01 Mar 1999
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Handle: RePEc:sce:scecf9:111

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Postal: CEF99, Boston College, Department of Economics, Chestnut Hill MA 02467 USA
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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. Pritsker, Matt, 1998. "Nonparametric Density Estimation and Tests of Continuous Time Interest Rate Models," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 11(3), pages 449-87.
  2. Gallant, A. Ronald & Tauchen, George, 1996. "Which Moments to Match?," Econometric Theory, Cambridge University Press, vol. 12(04), pages 657-681, October. [Downloadable!]
  3. repec:cup:etheor:v:12:y:1996:i:4:p:657-81 is not listed on IDEAS
  4. David A. Chapman & Neil D. Pearson, 1998. "Is the Short Rate Drift Actually Nonlinear?," Finance 9808005, EconWPA. [Downloadable!]
  5. Tauchen, George E. & Gallant, A. Ronald, 1995. "Which Moments to Match," Working Papers 95-20, Duke University, Department of Economics.
  6. Ait-Sahalia, Yacine, 1996. "Testing Continuous-Time Models of the Spot Interest Rate," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 9(2), pages 385-426. [Downloadable!] (restricted)
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  1. A. Mele, 2000. "Fundamental Properties of Bond Prices in Models of the Short-Term Rate," THEMA Working Papers 2000-39, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise. [Downloadable!]
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