The Volatility of the Instantaneous Spot Interest Rate Implied by Arbitrage Pricing - A Dynamic Bayesian Approach
AbstractThis paper considers the estimation of the volatility of the instantaneous short interest rate from a new perspective. Rather than using discretely compounded market rates as a proxy for the instantaneous short rate of interest, we derive a relationship between observed LIBOR rates and certain unobserved instantaneous forward rates. We determine the stochastic dynamics for these rates under the risk- neutral measure and propose a filtering estimation algorithm for a time- discretised version of the resulting interest rate dynamics based on dynamic Bayesian updating. The method is applied to US Treasury rates of various maturities and is found to give a reasonable model fit.
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Bibliographic InfoPaper provided by EconWPA in its series Finance with number 0409002.
Length: 29 pages
Date of creation: 01 Sep 2004
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Find related papers by JEL classification:
- G - Financial Economics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-09-05 (All new papers)
- NEP-CFN-2004-09-05 (Corporate Finance)
- NEP-CMP-2004-09-05 (Computational Economics)
- NEP-ETS-2004-09-05 (Econometric Time Series)
- NEP-FIN-2004-09-05 (Finance)
- NEP-RMG-2004-09-05 (Risk Management)
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