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A re-examination of the empirical performance of the Longstaff and Schwartz two-factor term structure model using real yield data

Author

Listed:
  • Robert Faff

    (Finance Cluster, UQ Business School, Australia)

  • Sirimon Treepongkaruna

    (Accounting and Finance, UWA Business School, Australia)

Abstract

In this study, we apply the Longstaff and Schwartz (1992) two-factor term structure model to real yields across eight countries. As such, we improve on many prior studies that have inappropriately tested this formulation using nominal yield data. We use the generalized method of moments to test the cross-sectional restrictions imposed by the Longstaff and Schwartz model, as well as the Cox–Ingersoll–Ross one-factor model. Further, we compare the forecasting ability from both models. Our findings support the superiority of the two-factor model. We confirm general reliability of prior research in this area, despite the unfortunate reliance on nominal data in such earlier tests.

Suggested Citation

  • Robert Faff & Sirimon Treepongkaruna, 2013. "A re-examination of the empirical performance of the Longstaff and Schwartz two-factor term structure model using real yield data," Australian Journal of Management, Australian School of Business, vol. 38(2), pages 333-352, August.
    • Handle: RePEc:sae:ausman:v:38:y:2013:i:2:p:333-352
    DOI: 10.1177/0312896212443691
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    References listed on IDEAS

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    More about this item

    Keywords

    Longstaff–Schwartz two-factor model; multi-country test; real yield data; term structure;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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