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Analyzing interest rate risk: Stochastic volatility in the term structure of government bond yields

  • Hautsch, Nikolaus
  • Ou, Yangguoyi

We propose a Nelson–Siegel type interest rate term structure model where the underlying yield factors follow autoregressive processes with stochastic volatility. The factor volatilities parsimoniously capture risk inherent to the term structure and are associated with the time-varying uncertainty of the yield curve’s level, slope and curvature. Estimating the model based on US government bond yields applying Markov chain Monte Carlo techniques we find that the factor volatilities follow highly persistent processes. We show that yield factors and factor volatilities are closely related to macroeconomic state variables as well as the conditional variances thereof.

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File URL: http://www.sciencedirect.com/science/article/pii/S0378426612001896
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Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 36 (2012)
Issue (Month): 11 ()
Pages: 2988-3007

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Handle: RePEc:eee:jbfina:v:36:y:2012:i:11:p:2988-3007
Contact details of provider: Web page: http://www.elsevier.com/locate/jbf

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