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A Multifactor, Nonlinear, Continuous-Time Model of Interest Rate Volatility

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  • Jacob Boudoukh
  • Matthew Richardson
  • Richard Stanton
  • Robert Whitelaw

Abstract

This paper presents a general, nonlinear version of existing multifactor models, such as Longstaff and Schwartz (1992). The novel aspect of our approach is that rather than choosing the model parameterization out of "thin air", our processes are generated from the data using approximation methods for multifactor continuous-time Markov processes. In applying this technique to the short- and long-end of the term structure for a general two-factor diffusion process for interest rates, a major finding is that the volatility of interest rates is increasing in the level of interest rates only for sharply upward sloping term structures. In fact, the slope of the term structure plays a larger role in determining the magnitude of the diffusion coefficient. As an application, we analyze the model's implications for the term structure of term premiums.

Suggested Citation

  • Jacob Boudoukh & Matthew Richardson & Richard Stanton & Robert Whitelaw, 1999. "A Multifactor, Nonlinear, Continuous-Time Model of Interest Rate Volatility," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-042, New York University, Leonard N. Stern School of Business-.
  • Handle: RePEc:fth:nystfi:99-042
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    File URL: http://www.stern.nyu.edu/fin/workpapers/papers99/wpa99042.pdf
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    References listed on IDEAS

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    Cited by:

    1. D H Kim, 2005. "Nonlinearity in the Term Structure," Centre for Growth and Business Cycle Research Discussion Paper Series 51, Economics, The University of Manchester.
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    3. Dong Heon Kim, 2004. "Nonlinearity in the Term Structure," Econometric Society 2004 Far Eastern Meetings 440, Econometric Society.
    4. Jack Strauss & Mark E. Wohar, 2007. "Domestic‐Foreign Interest Rate Differentials: Near Unit Roots and Symmetric Threshold Models," Southern Economic Journal, John Wiley & Sons, vol. 73(3), pages 814-829, January.
    5. John Knight & Fuchun Li & Mingwei Yuan, 2006. "A Semiparametric Two-Factor Term Structure Model," Journal of Financial Econometrics, Oxford University Press, vol. 4(2), pages 204-237.

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