A tale of two yield curves: Modeling the joint term structure of dollar and euro interest rates
Modeling the joint term structure of interest rates in the United States and the European Union, the two largest economies in the world, is extremely important in international finance. In this article, we provide both theoretical and empirical analysis of multi-factor joint affine term structure models (ATSM) for dollar and euro interest rates. In particular, we provide a systematic classification of multi-factor joint ATSM similar to that of Dai and Singleton (2000). A principal component analysis of daily dollar and euro interest rates reveals four factors in the data. We estimate four-factor joint ATSM using the approximate maximum likelihood method of (Aït-Sahalia, 2002) and (Aït-Sahalia, forthcoming) and compare the in-sample and out-of-sample performances of these models using some of the latest nonparametric methods. We find that a new four-factor model with two common and two local factors captures the joint term structure dynamics in the US and the EU reasonably well.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
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.:
- Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-53, October.
- John H. Cochrane & Monika Piazzesi, 2002.
"Bond Risk Premia,"
NBER Working Papers
9178, National Bureau of Economic Research, Inc.
- 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.
- Mishkin, Frederic S., 1990.
"What does the term structure tell us about future inflation?,"
Journal of Monetary Economics,
Elsevier, vol. 25(1), pages 77-95, January.
- Frederic S. Mishkin, 1988. "What Does the Term Structure Tell Us About Future Inflation?," NBER Working Papers 2626, National Bureau of Economic Research, Inc.
- Mishkin, F.S., 1988. "What Does The Term Structure Tell Us About Future Inflation?," Papers fb-_88-29, Columbia - Graduate School of Business.
- Andrew Ang & Monika Piazzesi & Min Wei, 2004.
"What Does the Yield Curve Tell us about GDP Growth?,"
NBER Working Papers
10672, National Bureau of Economic Research, Inc.
- Andrew Ang & Monika Piazzesi & Min Wei, 2003. "What does the yield curve tell us about GDP growth?," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
- Ang, Andrew & Piazzesi, Monika & Wei, Min, 2006. "What does the yield curve tell us about GDP growth?," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 359-403.
- Aït-Sahalia, Yacine & Kimmel, Robert L., 2010.
"Estimating affine multifactor term structure models using closed-form likelihood expansions,"
Journal of Financial Economics,
Elsevier, vol. 98(1), pages 113-144, October.
- Yacine Aït-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.
- 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.
- Arturo Estrella & Gikas A. Hardouvelis, 1989.
"The term structure as a predictor of real economic activity,"
8907, Federal Reserve Bank of New York.
- Estrella, Arturo & Hardouvelis, Gikas A, 1991. " The Term Structure as a Predictor of Real Economic Activity," Journal of Finance, American Finance Association, vol. 46(2), pages 555-76, June.
- Singleton, Kenneth J., 2001. "Estimation of affine asset pricing models using the empirical characteristic function," Journal of Econometrics, Elsevier, vol. 102(1), pages 111-141, May.
- Egorov, Alexei V. & Hong, Yongmiao & Li, Haitao, 2006. "Validating forecasts of the joint probability density of bond yields: Can affine models beat random walk?," Journal of Econometrics, Elsevier, vol. 135(1-2), pages 255-284.
- 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.
- 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.
- 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.
- Michael J. Brennan & Yihong Xia, 2006. "International Capital Markets and Foreign Exchange Risk," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 753-795.
- 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.
- 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.
- Tauchen, George E. & Gallant, A. Ronald, 1995.
"Which Moments to Match,"
95-20, Duke University, Department of Economics.
- Georg Mosburger & Paul Schneider, 2005. "Modelling International Bond Markets with Affine Term Structure Models," Finance 0509003, EconWPA.
- 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.
- Qiang Dai & Kenneth J. Singleton, 2000. "Specification Analysis of Affine Term Structure Models," Journal of Finance, American Finance Association, vol. 55(5), pages 1943-1978, October.
- Egorov, Alexei V. & Li, Haitao & Xu, Yuewu, 2003. "Maximum likelihood estimation of time-inhomogeneous diffusions," Journal of Econometrics, Elsevier, vol. 114(1), pages 107-139, May.
When requesting a correction, please mention this item's handle: RePEc:eee:econom:v:162:y:2011:i:1:p:55-70. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.