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The rational expectation dynamics of a model for the term structure and monetary policy

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  • Luisa Malaguti
  • Costanza Torricelli

Abstract

We describe in this paper a variance reduction method based on control variates. The technique uses the fact that, if all stochastic assets but one are replaced in the payoff function by their mean, the resulting integral can most often be evaluated in closed form. We exploit this idea by applying the univariate payoff as control variate and develop a general Monte Carlo procedure, called Mean Monte Carlo (MMC). The method is then tested on a variety of multifactor options and compared to other Monte Carlo approaches or numerical techniques. The method is of easy and broad applicability and gives good results especially for low to medium dimension and in high volatility environments. Copyright Springer-Verlag Italia 2001

Suggested Citation

  • Luisa Malaguti & Costanza Torricelli, 2001. "The rational expectation dynamics of a model for the term structure and monetary policy," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 24(2), pages 137-152, November.
    • Handle: RePEc:spr:decfin:v:24:y:2001:i:2:p:137-152
    DOI: 10.1007/s102030170004
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    9. Gerlach, Stefan & Smets, Frank, 1997. "The term structure of Euro-rates: some evidence in support of the expectations hypothesis," Journal of International Money and Finance, Elsevier, vol. 16(2), pages 305-321, April.
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    18. Harris, Richard, 1998. "A Test of the Expectations Hypothesis of the Term Structure Using Cross-Section Data," Discussion Papers 9812, University of Exeter, Department of Economics.
    19. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, vol. 55(2), pages 391-407, March.
    20. Longstaff, Francis A & Schwartz, Eduardo S, 1992. "Interest Rate Volatility and the Term Structure: A Two-Factor General Equilibrium Model," Journal of Finance, American Finance Association, vol. 47(4), pages 1259-1282, September.
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    More about this item

    Keywords

    Mathematics Subject Classification (2000): 91B28; Journal of Economic Literature Classification: E43; E52;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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