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Improving the term structure of interest rates: two-factor models

Author

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  • Lourdes Gómez-Valle

    (Dpto. Economía Aplicada, Facultad de Ciencias Económicas y Empresariales, Universidad de Valladolid, Spain)

  • Julia Martínez-Rodríguez

    (Dpto. Economía Aplicada, Facultad de Ciencias Económicas y Empresariales, Universidad de Valladolid, Spain)

Abstract

We consider a new approach for estimating the coefficients of the term structure equation in two-factor models. This approach is based on the fact that the risk-neutral drifts of the factors are directly estimated. Therefore, the market prices of risk and the physical drifts do not have to be either identified or estimated. In order to study the finite properties of this approach, we generate trajectories in a stochastic volatility model. We find that the risk-neutral drifts and the yield curves are more accurately estimated. Finally, we show the supremacy of this approach by means of US Treasury Bill data. Copyright © 2009 John Wiley & Sons, Ltd.

Suggested Citation

  • Lourdes Gómez-Valle & Julia Martínez-Rodríguez, 2010. "Improving the term structure of interest rates: two-factor models," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(3), pages 275-287.
    • Handle: RePEc:ijf:ijfiec:v:15:y:2010:i:3:p:275-287
    DOI: 10.1002/ijfe.392
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