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Staying at Zero with Affine Processes: An Application to Term Structure Modelling

Author

Listed:
  • Alain Monfort
  • Fulvio Pegoraro
  • Jean-Paul Renne
  • G. Roussellet

Abstract

We build an Affine Term Structure Model that provides non-negative yields at any maturity and that is able to accommodate a short-term rate that stays at the zero lower bound (ZLB) for extended periods of time while longer-term rates feature high volatilities. We introduce these features through a new univariate non-negative affine process called ARG-Zero, and its multivariate affine counterpart (VARG), entailing conditional distributions with zero-point masses. The affine property of this new class of processes implies both explicit bond pricing and quasi-explicit lift-off probability formulas. We provide an empirical application to Japanese Government Bond (JGB) yields, observed weekly from June 1995 to May 2014 with maturities from six months to ten years. Our four-factor specification is able to closely match yield levels and to capture conditional yield volatilities.

Suggested Citation

  • Alain Monfort & Fulvio Pegoraro & Jean-Paul Renne & G. Roussellet, 2015. "Staying at Zero with Affine Processes: An Application to Term Structure Modelling," Working papers 558, Banque de France.
    • Handle: RePEc:bfr:banfra:558
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    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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