IDEAS home Printed from https://ideas.repec.org/a/eee/phsmap/v376y2007icp543-554.html

Empirical evaluation of the market price of risk using the CIR model

Author

Listed:
  • Bernaschi, M.
  • Torosantucci, L.
  • Uboldi, A.

Abstract

We describe a simple but effective method for the estimation of the market price of risk. The basic idea is to compare the results obtained by following two different approaches in the application of the Cox–Ingersoll–Ross (CIR) model. In the first case, we apply the non-linear least squares method to cross sectional data (i.e., all rates of a single day). In the second case, we consider the short rate obtained by means of the first procedure as a proxy of the real market short rate. Starting from this new proxy, we evaluate the parameters of the CIR model by means of martingale estimation techniques. The estimate of the market price of risk is provided by comparing results obtained with these two techniques, since this approach makes possible to isolate the market price of risk and evaluate, under the Local Expectations Hypothesis, the risk premium given by the market for different maturities. As a test case, we apply the method to data of the European Fixed Income Market.

Suggested Citation

  • Bernaschi, M. & Torosantucci, L. & Uboldi, A., 2007. "Empirical evaluation of the market price of risk using the CIR model," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 376(C), pages 543-554.
    • Handle: RePEc:eee:phsmap:v:376:y:2007:i:c:p:543-554
    DOI: 10.1016/j.physa.2006.10.072
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378437106011460
    Download Restriction: Full text for ScienceDirect subscribers only. Journal offers the option of making the article available online on Science direct for a fee of $3,000
    File URL: https://libkey.io/10.1016/j.physa.2006.10.072?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to

    for a different version of it.

    References listed on IDEAS

    as
    1. Markus Leippold & Liuren Wu, 2003. "Design and Estimation of Quadratic Term Structure Models," Review of Finance, European Finance Association, vol. 7(1), pages 47-73.
    2. John Y. Campbell & Robert J. Shiller, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 58(3), pages 495-514.
    3. Cox, John C. & Ingersoll Junior, Jonathan E. & Ross, Stephen A., 2007. "A theory of the term structure of interest rates," RAE - Revista de Administração de Empresas, FGV-EAESP Escola de Administração de Empresas de São Paulo (Brazil), vol. 47(2), April.
    4. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-489, October.
    5. 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.
    6. Thornton, Daniel L., 2006. "Tests of the Expectations Hypothesis: Resolving the Campbell-Shiller Paradox," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 511-542, March.
    7. Dai, Qiang & Singleton, Kenneth J., 2002. "Expectation puzzles, time-varying risk premia, and affine models of the term structure," Journal of Financial Economics, Elsevier, vol. 63(3), pages 415-441, March.
    8. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-384, March.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Robert Ferstl & Alex Weissensteiner, 2010. "Cash management using multi-stage stochastic programming," Quantitative Finance, Taylor & Francis Journals, vol. 10(2), pages 209-219.
    2. Grundke, Peter & Kühn, André, 2020. "The impact of the Basel III liquidity ratios on banks: Evidence from a simulation study," The Quarterly Review of Economics and Finance, Elsevier, vol. 75(C), pages 167-190.
    3. Weissensteiner, Alex, 2010. "Using the Black-Derman-Toy interest rate model for portfolio optimization," European Journal of Operational Research, Elsevier, vol. 202(1), pages 175-181, April.
    4. Robert Ferstl & Alexander Weissensteiner, 2011. "Backtesting Short-Term Treasury Management Strategies Based on Multi-Stage Stochastic Programming," Palgrave Macmillan Books, in: Gautam Mitra & Katharina Schwaiger (ed.), Asset and Liability Management Handbook, chapter 19, pages 469-494, Palgrave Macmillan.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Guidolin, Massimo & Thornton, Daniel L., 2018. "Predictions of short-term rates and the expectations hypothesis," International Journal of Forecasting, Elsevier, vol. 34(4), pages 636-664.
    2. Christensen, Bent Jesper & van der Wel, Michel, 2019. "An asset pricing approach to testing general term structure models," Journal of Financial Economics, Elsevier, vol. 134(1), pages 165-191.
    3. Guo, Bin & Huang, Fuzhe & Li, Kai, 2022. "Time to build and bond risk premia," Journal of Economic Dynamics and Control, Elsevier, vol. 136(C).
    4. Renato França & Raquel M. Gaspar, 2023. "On the Bias of the Unbiased Expectation Theory," Mathematics, MDPI, vol. 12(1), pages 1-20, December.
    5. Zeno Rotondi, 2006. "The Macroeconomy and the Yield Curve: A Review of the Literature with Some New Evidence," Giornale degli Economisti, GDE (Giornale degli Economisti e Annali di Economia), Bocconi University, vol. 65(2), pages 193-224, November.
    6. Peter Feldhütter & Christian Heyerdahl-Larsen & Philipp Illeditsch, 2018. "Risk Premia and Volatilities in a Nonlinear Term Structure Model [Quadratic term structure models: theory and evidence]," Review of Finance, European Finance Association, vol. 22(1), pages 337-380.
    7. Caldeira, João F. & Moura, Guilherme V. & Santos, André A.P., 2016. "Predicting the yield curve using forecast combinations," Computational Statistics & Data Analysis, Elsevier, vol. 100(C), pages 79-98.
    8. Almeida, Caio Ibsen Rodrigues de, 2005. "A Note on the Relation Between Principal Components and Dynamic Factors in Affine Term Structure Models," Brazilian Review of Econometrics, Sociedade Brasileira de Econometria - SBE, vol. 25(1), May.
    9. Jiang, George & Yan, Shu, 2009. "Linear-quadratic term structure models - Toward the understanding of jumps in interest rates," Journal of Banking & Finance, Elsevier, vol. 33(3), pages 473-485, March.
    10. Jordan, James V. & Mansi, Sattar A., 2003. "Term structure estimation from on-the-run Treasuries," Journal of Banking & Finance, Elsevier, vol. 27(8), pages 1487-1509, August.
    11. Yung, Julieta, 2021. "Can interest rate factors explain exchange rate fluctuations?," Journal of Empirical Finance, Elsevier, vol. 61(C), pages 34-56.
    12. Backus, David & Foresi, Silverio & Mozumdar, Abon & Wu, Liuren, 2001. "Predictable changes in yields and forward rates," Journal of Financial Economics, Elsevier, vol. 59(3), pages 281-311, March.
    13. Inci, Ahmet Can, 2007. "US-Swiss term structures and exchange rate dynamics," Global Finance Journal, Elsevier, vol. 18(2), pages 270-288.
    14. Almeida, Caio & Graveline, Jeremy J. & Joslin, Scott, 2011. "Do interest rate options contain information about excess returns?," Journal of Econometrics, Elsevier, vol. 164(1), pages 35-44, September.
    15. Gourieroux, Christian & Sufana, Razvan, 2011. "Discrete time Wishart term structure models," Journal of Economic Dynamics and Control, Elsevier, vol. 35(6), pages 815-824, June.
    16. Leo Krippner, 2009. "A theoretical foundation for the Nelson and Siegel class of yield curve models," Reserve Bank of New Zealand Discussion Paper Series DP2009/10, Reserve Bank of New Zealand.
    17. Greg Duffee, 2011. "Forecasting with the term structure: The role of no-arbitrage restrictions," Economics Working Paper Archive 576, The Johns Hopkins University,Department of Economics.
    18. Modena, Matteo, 2008. "The term structure and the expectations hypothesis: a threshold model," MPRA Paper 9611, University Library of Munich, Germany.
    19. Leo Krippner, 2011. "Modifying Gaussian term structure models when interest rates are near the zero lower bound," CAMA Working Papers 2011-36, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    20. repec:hum:wpaper:sfb649dp2008-053 is not listed on IDEAS
    21. Driessen, Joost & Melenberg, Bertrand & Nijman, Theo, 2005. "Testing affine term structure models in case of transaction costs," Journal of Econometrics, Elsevier, vol. 126(1), pages 201-232, May.

    More about this item

    Keywords

    ;
    ;
    ;
    ;

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:phsmap:v:376:y:2007:i:c:p:543-554. See general information about how to correct material in RePEc.

    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 CitEc recognized a bibliographic reference but did not link an item in RePEc 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 RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.journals.elsevier.com/physica-a-statistical-mechpplications/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.