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Nonlinear Drift And Stochastic Volatility: An Empirical Investigation Of Short-Term Interest Rate Models

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  • Licheng Sun

Abstract

In this article I provide new evidence on the role of nonlinear drift and stochastic volatility in interest rate modeling. I compare various model specifications for the short-term interest rate using the data from five countries. I find that modeling the stochastic volatility in the short rate is far more important than specifying the shape of the drift function. The empirical support for nonlinear drift is weak with or without the stochastic volatility factor. Although a linear drift stochastic volatility model fits the international data well, I find that the level effect differs across countries. 2003 The Southern Finance Association and the Southwestern Finance Association.

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  • Licheng Sun, 2003. "Nonlinear Drift And Stochastic Volatility: An Empirical Investigation Of Short-Term Interest Rate Models," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 26(3), pages 389-404.
  • Handle: RePEc:bla:jfnres:v:26:y:2003:i:3:p:389-404
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    Cited by:

    1. Ryohei Kawata & Masaaki Kijima, 2007. "Value-at-risk in a market subject to regime switching," Quantitative Finance, Taylor & Francis Journals, vol. 7(6), pages 609-619.
    2. Muteba Mwamba, John & Thabo, Lethaba & Uwilingiye, Josine, 2014. "Modelling the short-term interest rate with stochastic differential equation in continuous time: linear and nonlinear models," MPRA Paper 64386, University Library of Munich, Germany.
    3. Ram Bhar & Carl Chiarella & Hing Hung & Wolfgang Runggaldier, 2004. "The Volatility of the Instantaneous Spot Interest Rate Implied by Arbitrage Pricing - A Dynamic Bayesian Approach," Finance 0409002, EconWPA.

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