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Modelling International Bond Markets with Affine Term Structure Models

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Author Info
Georg Mosburger (University of Vienna)
Paul Schneider (Vienna University of Economics & Business Administration)

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Abstract

This paper investigates the performance of international affine term structure models (ATSMs) that are driven by a mutual set of global state variables. We discuss which mixture of Gaussian and square root processes is best suited for modelling international bond markets. We derive necessary conditions for the correlation and volatility structure of mixture models to accommodate various empirical stylized facts such as the forward premium puzzle and differently shaped yield curves. Using UK-US data we estimate international ATSMs taking into account the joint transition density of yields and exchange rates without assuming normality. We find strong empirical evidence for negatively correlated global factors in international bond markets. Further, the empirical results do not support the existence of local factors in the UK-US setting, suggesting that diversification benefits from holding currency- hedged bond portfolios in these markets are likely to be small. Altogether, we find that mixture models greatly enhance the performance of ATSMs.

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Publisher Info
Paper provided by EconWPA in its series Finance with number 0509003.

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Length: 51 pages
Date of creation: 04 Sep 2005
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Handle: RePEc:wpa:wuwpfi:0509003

Note: Type of Document - pdf; pages: 51
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Web page: http://129.3.20.41

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Related research
Keywords: International affine term structure models; Estimation; Exchange rate; Model Selection;

Find related papers by JEL classification:
C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
F31 - International Economics - - International Finance - - - Foreign Exchange
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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References listed on IDEAS
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. Constantinides, George M, 1992. "A Theory of the Nominal Term Structure of Interest Rates," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 5(4), pages 531-52. [Downloadable!] (restricted)
  2. Hans Dewachter & Konstantijn Maes, 2001. "An Admissible Affine Model for Joint Term Structure Dynamics of Interest Rates," International Economics Working Papers Series wpie001, Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics. [Downloadable!]
  3. Pierre Collin-Dufresne & Robert S. Goldstein, 2002. "Do Bonds Span the Fixed Income Markets? Theory and Evidence for Unspanned Stochastic Volatility," Journal of Finance, American Finance Association, vol. 57(4), pages 1685-1730, 08. [Downloadable!] (restricted)
  4. Geert Bekaert, 1996. "The Time Variation of Risk and Return in Foreign Exchange Markets: A General Equilibrium Perspective," NBER Working Papers 4818, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02. [Downloadable!] (restricted)
  6. Hodrick, Robert & Vassalou, Maria, 2002. "Do we need multi-country models to explain exchange rate and interest rate and bond return dynamics?," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1275-1299, July. [Downloadable!] (restricted)
  7. Yacine Ait-Sahalia & Robert Kimmel, 2002. "Estimating Affine Multifactor Term Structure Models Using Closed-Form Likelihood Expansions," NBER Technical Working Papers 0286, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  8. David K. Backus, 2001. "Affine Term Structure Models and the Forward Premium Anomaly," Journal of Finance, American Finance Association, vol. 56(1), pages 279-304, 02. [Downloadable!] (restricted)
  9. Pierre Collin-Dufresne, 2001. "On the Term Structure of Default Premia in the Swap and LIBOR Markets," Journal of Finance, American Finance Association, vol. 56(3), pages 1095-1115, 06. [Downloadable!] (restricted)
  10. Inci, Ahmet Can & Lu, Biao, 2004. "Exchange rates and interest rates: can term structure models explain currency movements?," Journal of Economic Dynamics and Control, Elsevier, vol. 28(8), pages 1595-1624, June. [Downloadable!] (restricted)
  11. Ahn, Dong-Hyun, 2004. "Common Factors and Local Factors: Implications for Term Structures and Exchange Rates," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(01), pages 69-102, March. [Downloadable!]
  12. Qiang Dai & Kenneth Singleton, 2003. "Term Structure Dynamics in Theory and Reality," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 16(3), pages 631-678, July. [Downloadable!] (restricted)
  13. Yacine Ait-Sahalia, 2002. "Closed-Form Likelihood Expansions for Multivariate Diffusions," NBER Working Papers 8956, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  14. Bansal, Ravi, 1997. "An Exploration of the Forward Premium Puzzle in Currency Markets," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 10(2), pages 369-403.
  15. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June. [Downloadable!] (restricted)
    Other versions:
  16. Yacine Ait-Sahalia, 2002. "Maximum Likelihood Estimation of Discretely Sampled Diffusions: A Closed-form Approximation Approach," Econometrica, Econometric Society, vol. 70(1), pages 223-262, January. [Downloadable!] (restricted)
  17. Jefferson Duarte, 2004. "Evaluating an Alternative Risk Preference in Affine Term Structure Models," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 17(2), pages 379-404. [Downloadable!] (restricted)
  18. Brandt, Michael W. & Santa-Clara, Pedro, 2002. "Simulated likelihood estimation of diffusions with an application to exchange rate dynamics in incomplete markets," Journal of Financial Economics, Elsevier, vol. 63(2), pages 161-210, February. [Downloadable!] (restricted)
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Cited by:
(explanations, 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. Ait-Sahalia, Yacine & Kimmel, Robert L., 2008. "Estimating Affine Multifactor Term Structure Models Using Closed-Form Likelihood Expansions," Working Paper Series 2008-19, Ohio State University, Charles A. Dice Center for Research in Financial Economics. [Downloadable!]
    Other versions:
  2. Kimmel, Robert L., 2007. "Complex Times: Asset Pricing and Conditional Moments under Non-affine Diffusions," Working Paper Series 2007-6, Ohio State University, Charles A. Dice Center for Research in Financial Economics. [Downloadable!]
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