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Which Model for the Italian Interest Rates?

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Author Info

  • Monica Gentile
  • Roberto Renò

Abstract

In the recent years, di usion models for interest rates became very pop- ular. In this paper, we try to do a selection of a suitable di usion model for the Italian interest rates. Our data set is given by the yields on three-month BOT, from 1981 to 2001, for a total of 470 observations. We investigate among stochastic volatility models, paying more attention to a ne models. Estimating di usion models via maximum likelihood,which would lead to e ciency, is usually unfeasible since the transition density is not available. Recently it has been proposed a method of mo- ments which gains full e ciency, hence its name of E cient Method of Moments (EMM); it selects the moments as the scores of an auxiliary model, to be computed via simulation,thus EMM is suitable to di usions whose transition density is un- known, but which are convenient to simulate. The auxiliary model is selected among a family of densities which spans the density space. As a by-product, EMM provides diagnostics which are easy to compute and to interpret. We nd evidence that one- factor models are rejected, while a logarithmic speci cation of the volatility provides the best t to the data, in agreement with the ndings on U.S. data. Moreover, we provide evidence that this model allows a more exible representation of the yield curve.

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Bibliographic Info

Paper provided by Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy in its series LEM Papers Series with number 2002/02.

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Date of creation: 06 Dec 2002
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Handle: RePEc:ssa:lemwps:2002/02

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Related research

Keywords: Estimation by simulation; method of moments; stochastic differential equations; diffusions; interest rate term structure; yield curve.;

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References

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  12. Pierluigi Balduzzi & Edwin J. Elton & T. Clifton Green, 1997. "Economic News and the Yield Curve: Evidence from the U.S. Treasury Market," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-005, New York University, Leonard N. Stern School of Business-.
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Cited by:
  1. Mari, Carlo & Reno, Roberto, 2005. "Credit risk analysis of mortgage loans: An application to the Italian market," European Journal of Operational Research, Elsevier, vol. 163(1), pages 83-93, May.

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