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A tractable framework for zero lower bound Gaussian term structure models

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Abstract

When nominal interest rates are near their zero lower bound (ZLB), as in many developed economies at the time of writing, it is theoretically untenable to apply the popular class of Gaussian affine term structure models (GATSMs) given their inherent material probabilities of negative interest rates. Hence, I propose a new and tractable modification for GATSMs that enforces the ZLB, and which approximates the fully arbitrage-free but much less tractable framework proposed in Black (1995). I apply my framework to United States yield curve data, with robust estimation via the iterated extended Kalman filter, and first show that the two-factor results are very similar to those from a comparable Black model. I then estimate two- and three-factor models with longer-maturity data sets to illustrate that my ZLB framework can readily be applied in circumstances that would be computationally burdensome or infeasible within the Black framework.

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  • Leo Krippner, 2013. "A tractable framework for zero lower bound Gaussian term structure models," Reserve Bank of New Zealand Discussion Paper Series DP2013/02, Reserve Bank of New Zealand.
    • Handle: RePEc:nzb:nzbdps:2013/02
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    JEL classification:

    • 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
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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