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Choosing the Right Error in Term Structure Models


  • Bobadilla, G.F.


We study the influence of measurement error specification on estimation results in the context of continuous-time models of the term structure of interest rates. For this purpose, we estimate a two-factor mean-reverting stochastic model of the recent evolution of the Spanish term structure. The model is estimated under a baseline specification where errors are independent both serially and cross-sectionally, and the factors are general (i.e. unobservable), and under various other specifications, where factors are assumed to be observable, or where errors have either serial correlation, cross-sectional correlation, or both. We find that error specification has an important impact on the value of estimated fundamental parameters, i.e. those that define the continuous-time theoretical model. We conclude that the choice of specification may depend on what is the purpose of estimation, whether fitting, prediction, or accurate estimation of significant economic parameters.

Suggested Citation

  • Bobadilla, G.F., 1999. "Choosing the Right Error in Term Structure Models," Papers 9904, Centro de Estudios Monetarios Y Financieros-.
  • Handle: RePEc:fth:cemfdt:9904

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    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C40 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - General
    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects


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