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Pricing the term structure with linear regressions

  • Adrian, Tobias
  • Crump, Richard K.
  • Moench, Emanuel

We show how to price the time series and cross section of the term structure of interest rates using a three-step linear regression approach. Our method allows computationally fast estimation of term structure models with a large number of pricing factors. We present specification tests favoring a model using five principal components of yields as factors. We demonstrate that this model outperforms the Cochrane and Piazzesi (2008) four-factor specification in out-of-sample exercises but generates similar in-sample term premium dynamics. Our regression approach can also incorporate unspanned factors and allows estimation of term structure models without observing a zero-coupon yield curve.

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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 110 (2013)
Issue (Month): 1 ()
Pages: 110-138

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Handle: RePEc:eee:jfinec:v:110:y:2013:i:1:p:110-138
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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