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Risk Premia and Volatilities in a Nonlinear Term Structure Model
[Quadratic term structure models: theory and evidence]

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Listed:
  • Peter Feldhütter
  • Christian Heyerdahl-Larsen
  • Philipp Illeditsch

Abstract

We introduce a reduced-form term structure model with closed-form solutions for yields where the short rate and market prices of risk are nonlinear functions of Gaussian state variables. The nonlinear model with three factors matches the time-variation in expected excess returns and yield volatilities of US Treasury bonds from 1961 to 2014. Yields and their variances depend on only three factors, yet the model exhibits features consistent with Unspanned Risk Premia (URP) and Unspanned Stochastic Volatility (USV).

Suggested Citation

  • 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.
    • Handle: RePEc:oup:revfin:v:22:y:2018:i:1:p:337-380.
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