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MCMC Based Estimation of Term Structure Models

  • Mikkelsen, Peter

    (Department of Finance, Aarhus School of Business)

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    We develop a state space framework for estimating term structure models, where latent Markovian state variables are mapped non-linearly into observable market data. The measurement equation of our framework is explicitly constructed such that it takes raw market prices and rates as direct inputs. We thus avoid entirely, the need for data preprocessing, such as the use of ad hoc interpolation and data smoothing techniques. As our general estimation approach, we demonstrate how Markov chain Monte Carlo techniques are well suited for handling complex functional relations between state vari-ables and data, parameter restrictions and other features of popular term structure mod-els, which have proved hard to handle for alternative econometric techniques. Our estimation framework therefore handles popular multi-factor model specifications such as exponential affine and quadratic models, but facilitates richer Markovian HJM model specifications as well. Efficient Markov chain Monte Carlo implementations are highly model dependent. Therefore, having developed the general estimation principles of our framework, we demonstrate how one could approach sampler specification for a particular model example which we fit to a panel data set of swap and money market rates.

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    Paper provided by University of Aarhus, Aarhus School of Business, Department of Business Studies in its series Finance Working Papers with number 01-7.

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    Length: 39 pages
    Date of creation: 21 May 2001
    Date of revision:
    Handle: RePEc:hhb:aarfin:2001_007
    Contact details of provider: Postal: The Aarhus School of Business, Fuglesangs Allé 4, DK-8210 Aarhus V, Denmark
    Fax: + 45 86 15 19 43
    Web page: http://www.asb.dk/about/departments/bs.aspx
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    1. Chan, K C, et al, 1992. " An Empirical Comparison of Alternative Models of the Short-Term Interest Rate," Journal of Finance, American Finance Association, vol. 47(3), pages 1209-27, July.
    2. Björk, Tomas & Christensen, Bent Jesper, 1997. "Interest Rate Dynamics and Consistent Forward Rate Curves," SSE/EFI Working Paper Series in Economics and Finance 209, Stockholm School of Economics.
    3. J. Durbin & S. J. Koopman, 2000. "Time series analysis of non-Gaussian observations based on state space models from both classical and Bayesian perspectives," Journal of the Royal Statistical Society Series B, Royal Statistical Society, vol. 62(1), pages 3-56.
    4. Sangjoon Kim & Neil Shephard, 1994. "Stochastic volatility: likelihood inference and comparison with ARCH models," Economics Papers 3., Economics Group, Nuffield College, University of Oxford.
    5. Donald W.K. Andrews, 1988. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Cowles Foundation Discussion Papers 877R, Cowles Foundation for Research in Economics, Yale University, revised Jul 1989.
    6. Duffie, Darrell & Singleton, Kenneth J, 1997. " An Econometric Model of the Term Structure of Interest-Rate Swap Yields," Journal of Finance, American Finance Association, vol. 52(4), pages 1287-1321, September.
    7. Durbin, J. & Koopman, S.J.M., 1998. "Time Series Analysis of Non-Gaussian Observations Based on State Space Models from Both Classical and Bayesian Perspectives," Discussion Paper 1998-142, .
    8. Sandmann, Gleb & Koopman, Siem Jan, 1998. "Estimation of stochastic volatility models via Monte Carlo maximum likelihood," Journal of Econometrics, Elsevier, vol. 87(2), pages 271-301, September.
    9. Jacquier, Eric & Polson, Nicholas G & Rossi, Peter E, 2002. "Bayesian Analysis of Stochastic Volatility Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 69-87, January.
    10. Siddhartha Chib & Edward Greenberg, 1994. "Markov Chain Monte Carlo Simulation Methods in Econometrics," Econometrics 9408001, EconWPA, revised 24 Oct 1994.
    11. Neil Shephard, 2005. "Stochastic Volatility," Economics Papers 2005-W17, Economics Group, Nuffield College, University of Oxford.
    12. repec:cup:etheor:v:12:y:1996:i:3:p:409-31 is not listed on IDEAS
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