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

  • Lourdes Gómez-Valle

    (Dpto. Econom�a Aplicada, Facultad de Ciencias Económicas y Empresariales, Universidad de Valladolid, Spain)

  • Julia Mart�nez-Rodr�guez

    (Dpto. Econom�a Aplicada, Facultad de Ciencias Económicas y Empresariales, Universidad de Valladolid, Spain)

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    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.

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    File URL: http://hdl.handle.net/10.1002/ijfe.392
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    Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

    Volume (Year): 15 (2010)
    Issue (Month): 3 ()
    Pages: 275-287

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    Handle: RePEc:ijf:ijfiec:v:15:y:2010:i:3:p:275-287
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    1. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    2. Manuel Moreno, 1996. "A two-mean reverting-factor model of the term structure of interest rates," Economics Working Papers 193, Department of Economics and Business, Universitat Pompeu Fabra.
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    12. Yacine Ait-Sahalia, 1995. "Testing Continuous-Time Models of the Spot Interest Rate," NBER Working Papers 5346, National Bureau of Economic Research, Inc.
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    18. Gómez-Valle, Lourdes & Marti­nez-Rodri­guez, Julia, 2008. "Modelling the term structure of interest rates: An efficient nonparametric approach," Journal of Banking & Finance, Elsevier, vol. 32(4), pages 614-623, April.
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