A Test of the Cox, Ingersoll, and Ross Model of the Term Structure

We present a test of the theory of the term structure developed by Cox, Ingersoll, and Ross (CIR). The econometric method uses Hansen’s Generalized Method of Moments and exploits the probability distribution of the single state variable that determines real bond prices. The approach avoids problems due to measurement errors in bond prices; it does not employ data on aggregate consumption; and it enables the estimation of a continuous time model based on discretely-sampled data. The tests indicate that the model for real indexed bonds that underlies all the alternative specifications in CIR performs reasonably well when confronted with short-term Treasury Bill data. The parameter estimates indicate that term premiums are positive and that the term structure of indexed bonds can admit several shapes. However, we find it difficult to rationalize the sample serial correlation in Treasury Bill returns using our estimates of the CIR parameters.