IDEAS home Printed from https://ideas.repec.org/p/fip/fedfwp/2014-03.html
   My bibliography  Save this paper

Can Spanned Term Structure Factors Drive Stochastic Yield Volatility?

Author

Listed:
  • Christensen, Jens H.E.

    () (Federal Reserve Bank of San Francisco)

  • Lopez, Jose A.

    () (Federal Reserve Bank of San Francisco)

  • Rudebusch, Glenn D.

    () (Federal Reserve Bank of San Francisco)

Abstract

The ability of the usual factors from empirical arbitrage-free representations of the term structure—that is, spanned factors—to account for interest rate volatility dynamics has been much debated. We examine this issue with a comprehensive set of new arbitrage-free term structure specifications that allow for spanned stochastic volatility to be linked to one or more of the yield curve factors. Using U.S. Treasury yields, we find that much realized stochastic volatility cannot be associated with spanned term structure factors. However, a simulation study reveals that the usual realized volatility metric is misleading when yields contain plausible measurement noise. We argue that other metrics should be used to validate stochastic volatility models.

Suggested Citation

  • Christensen, Jens H.E. & Lopez, Jose A. & Rudebusch, Glenn D., 2014. "Can Spanned Term Structure Factors Drive Stochastic Yield Volatility?," Working Paper Series 2014-3, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfwp:2014-03
    DOI: 10.24148/wp2014-03
    as

    Download full text from publisher

    File URL: http://www.frbsf.org/economic-research/files/wp2014-03.pdf
    File Function: Full text
    Download Restriction: no

    References listed on IDEAS

    as
    1. Koopman, Siem Jan & Mallee, Max I. P. & Van der Wel, Michel, 2010. "Analyzing the Term Structure of Interest Rates Using the Dynamic Nelson–Siegel Model With Time-Varying Parameters," Journal of Business & Economic Statistics, American Statistical Association, vol. 28(3), pages 329-343.
    2. Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2014. "Do Central Bank Liquidity Facilities Affect Interbank Lending Rates?," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 32(1), pages 136-151, January.
    3. Duffee, Gregory R, 1999. "Estimating the Price of Default Risk," Review of Financial Studies, Society for Financial Studies, vol. 12(1), pages 197-226.
    4. Collin-Dufresne, Pierre & Goldstein, Robert S. & Jones, Christopher S., 2009. "Can interest rate volatility be extracted from the cross section of bond yields?," Journal of Financial Economics, Elsevier, vol. 94(1), pages 47-66, October.
    5. Jagannathan, Ravi & Kaplin, Andrew & Sun, Steve, 2003. "An evaluation of multi-factor CIR models using LIBOR, swap rates, and cap and swaption prices," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 113-146.
    6. Michael D. Bauer & Glenn D. Rudebusch & Jing Cynthia Wu, 2012. "Correcting Estimation Bias in Dynamic Term Structure Models," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 30(3), pages 454-467, April.
    7. Jacobs, Kris & Karoui, Lotfi, 2009. "Conditional volatility in affine term-structure models: Evidence from Treasury and swap markets," Journal of Financial Economics, Elsevier, vol. 91(3), pages 288-318, March.
    8. Dong-Hyun Ahn & Robert F. Dittmar, 2002. "Quadratic Term Structure Models: Theory and Evidence," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 243-288, March.
    9. Pierre Collin-Dufresne & Robert S. Goldstein, 2002. "Do Bonds Span the Fixed Income Markets? Theory and Evidence for Unspanned Stochastic Volatility," Journal of Finance, American Finance Association, vol. 57(4), pages 1685-1730, August.
    10. Cheridito, Patrick & Filipovic, Damir & Kimmel, Robert L., 2007. "Market price of risk specifications for affine models: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 83(1), pages 123-170, January.
    11. Hautsch, Nikolaus & Ou, Yangguoyi, 2012. "Analyzing interest rate risk: Stochastic volatility in the term structure of government bond yields," Journal of Banking & Finance, Elsevier, vol. 36(11), pages 2988-3007.
    12. Jens H. E. Christensen & Glenn D. Rudebusch, 2012. "The Response of Interest Rates to US and UK Quantitative Easing," Economic Journal, Royal Economic Society, vol. 122(564), pages 385-414, November.
    13. Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2010. "Inflation Expectations and Risk Premiums in an Arbitrage-Free Model of Nominal and Real Bond Yields," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 143-178, September.
    14. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Paul Labys, 2003. "Modeling and Forecasting Realized Volatility," Econometrica, Econometric Society, vol. 71(2), pages 579-625, March.
    15. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, February.
    16. Joost Driessen, 2005. "Is Default Event Risk Priced in Corporate Bonds?," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 165-195.
    17. Ruslan Bikbov & Mikhail Chernov, 2011. "Yield Curve and Volatility: Lessons from Eurodollar Futures and Options," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 9(1), pages 66-105, Winter.
    18. Torben G. Andersen & Luca Benzoni, 2010. "Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification Test for Affine Term Structure Models," Journal of Finance, American Finance Association, vol. 65(2), pages 603-653, April.
    19. Dai, Qiang & Singleton, Kenneth J., 2002. "Expectation puzzles, time-varying risk premia, and affine models of the term structure," Journal of Financial Economics, Elsevier, vol. 63(3), pages 415-441, March.
    20. Ruslan Bikbov & Mikhail Chernov, 2009. "Unspanned Stochastic Volatility in Affine Models: Evidence from Eurodollar Futures and Options," Management Science, INFORMS, vol. 55(8), pages 1292-1305, August.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. repec:eee:ejores:v:262:y:2017:i:3:p:1116-1135 is not listed on IDEAS
    2. Shin, Minchul & Zhong, Molin, 2017. "Does realized volatility help bond yield density prediction?," International Journal of Forecasting, Elsevier, vol. 33(2), pages 373-389.
    3. Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2016. "Pricing Deflation Risk with US Treasury Yields," Review of Finance, European Finance Association, vol. 20(3), pages 1107-1152.
    4. repec:bfr:rueban:2017:52 is not listed on IDEAS
    5. Monfort, Alain & Pegoraro, Fulvio & Renne, Jean-Paul & Roussellet, Guillaume, 2017. "Staying at zero with affine processes: An application to term structure modelling," Journal of Econometrics, Elsevier, vol. 201(2), pages 348-366.

    More about this item

    Keywords

    arbitrage-free Nelson-Siegel model; term structure modeling; interest rate risk; model validation;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • 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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedfwp:2014-03. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Federal Reserve Bank of San Francisco Research Library). General contact details of provider: http://edirc.repec.org/data/frbsfus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.