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Tractable Term Structure Models

Author

Listed:
  • Anh Le
  • Bruno Feunou
  • Christian Lundblad
  • Jean-Sébastien Fontaine

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 due to a better fit of the volatility dynamics and a more efficient estimation of the return dynamics. Further, standard shadow rate and stochastic volatility models exhibit important restrictions that are largely absent in our approach.

Suggested Citation

  • Anh Le & Bruno Feunou & Christian Lundblad & Jean-Sébastien Fontaine, 2015. "Tractable Term Structure Models," Staff Working Papers 15-46, Bank of Canada.
  • Handle: RePEc:bca:bocawp:15-46
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    More about this item

    Keywords

    Asset Pricing; Interest rates; International financial markets; International topics; Transmission of monetary policy; Uncertainty and monetary policy;
    All these keywords.

    JEL classification:

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

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