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Tractable Term Structure Models

Author

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  • Bruno Feunou

    (Bank of Canada, Ottawa, Ontario K1A 0G9, Canada)

  • Jean-Sébastien Fontaine

    (Bank of Canada, Ottawa, Ontario K1A 0G9, Canada)

  • Anh Le

    (Smeal College of Business, Pennsylvania State University, University Park, Pennsylvania 16801)

  • Christian Lundblad

    (Kenan–Flagler Business School, University of North Carolina, Chapel Hill, North Carolina 27599-3490)

Abstract

We introduce a new framework that facilitates term structure modeling with both positive interest rates and flexible time series dynamics but that is also tractable, meaning amenable to quick and robust estimation. Using both simulations and U.S. historical data, we compare our approach with benchmark Gaussian and stochastic volatility models as well as a shadow rate model that enforces positive interest rates. Our approach, which remains arbitrarily close to arbitrage free, offers a more accurate characterization of bond Sharpe ratios because of a better fit of the volatility dynamics and a more efficient estimation of the return dynamics. Further, the shadow rate and stochastic volatility models exhibit important restrictions that are largely absent in our approach.

Suggested Citation

  • Bruno Feunou & Jean-Sébastien Fontaine & Anh Le & Christian Lundblad, 2022. "Tractable Term Structure Models," Management Science, INFORMS, vol. 68(11), pages 8411-8429, November.
  • Handle: RePEc:inm:ormnsc:v:68:y:2022:i:11:p:8411-8429
    DOI: 10.1287/mnsc.2021.4214
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    5. John W. Keating & Logan J. Kelly & A. Lee Smith & Victor J. Valcarcel, 2019. "A Model of Monetary Policy Shocks for Financial Crises and Normal Conditions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(1), pages 227-259, February.
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    8. Martin M. Andreasen & Andrew C. Meldrum, 2018. "A Shadow Rate or a Quadratic Policy Rule? The Best Way to Enforce the Zero Lower Bound in the United States," Finance and Economics Discussion Series 2018-056, Board of Governors of the Federal Reserve System (U.S.).

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    More about this item

    Keywords

    term structure; lower bound; no arbitrage; no dominance;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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