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A two-factor model of the German term structure of interest rates

  • Nuno Cassola
  • Jorge Barros Luis
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    This paper shows that a two-factor constant volatility model provides an adequate description of the dynamics and shape of the German term structure of interest rates from 1972 up to 1998. The model also provides reasonable estimates of the volatility and term premium curves. Following the conjecture that the two factors driving the German term structure of interest rates represent the ex-ante real interest rate and the expected inflation rate, the identification of one factor with expected inflation is discussed. The estimates are obtained using a Kalman filter and a maximum likelihood procedure including in the measurement equation both the yields and their volatilities.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/0960310022000020915
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    Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

    Volume (Year): 13 (2003)
    Issue (Month): 11 ()
    Pages: 783-806

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    Handle: RePEc:taf:apfiec:v:13:y:2003:i:11:p:783-806
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    18. Jacobs, Mike & Remolona, Eli & Wickens, Michael R., 1998. "What was the Market's View of UK Monetary Policy? Estimating Inflation Risk and Expected Inflation with Indexed Bonds," CEPR Discussion Papers 2022, C.E.P.R. Discussion Papers.
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