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Design and Estimation of Quadratic Term Structure Models

  • Markus Leippold

    (University of Zurich)

  • Liuren Wu

    (Fordham University)

We consider the design and estimation of quadratic term structure models. We start with a list of stylized facts on interest rates and interest rate derivatives, classified into three layers: (1) general statistical properties, (2) forecasting relations, and (3) conditional dynamics. We then investigate the implications of each layer of property on model design and strive to establish a mapping between evidence and model structures. We calibrate a two­factor model that approximates these three layers of properties well, and illustrate how the model can be applied to pricing interest rate derivatives.

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File URL: http://128.118.178.162/eps/fin/papers/0207/0207014.pdf
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Paper provided by EconWPA in its series Finance with number 0207014.

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Length: 49 pages
Date of creation: 30 Aug 2002
Date of revision:
Handle: RePEc:wpa:wuwpfi:0207014
Note: Type of Document - pdf; prepared on MikTex; to print on postscript; pages: 49 ; figures: included. produced via dvipdfm
Contact details of provider: Web page: http://128.118.178.162

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  1. David Backus & Silverio Foresi & Abon Mozumdar & Liuren Wu, 1998. "Predictable Changes in Yields and Forward Rates," NBER Working Papers 6379, National Bureau of Economic Research, Inc.
  2. Jean-Philippe Bouchaud & Nicolas Sagna & Rama Cont & Nicole El-Karoui & Marc Potters, 1997. "Phenomenology of the interest rate curve," Science & Finance (CFM) working paper archive 500048, Science & Finance, Capital Fund Management.
  3. Mishkin, F.S., 1988. "The Information In The Term Structure: Some Further Results," Papers fb-_88-26, Columbia - Graduate School of Business.
  4. William Roberds & Charles H. Whiteman, 1996. "Endogenous term premia and anomalies in the term structure of interest rates: explaining the predictability smile," Working Paper 96-11, Federal Reserve Bank of Atlanta.
  5. Geert Bekaert & Robert J. Hodrick & David Marshall, 1996. "On biases in tests of the expectations hypothesis of the term structure of interest rates," Working Paper Series, Issues in Financial Regulation WP-96-3, Federal Reserve Bank of Chicago.
  6. Geert Bekaert & Robert J. Hodrick & David A. Marshall, 1997. ""Peso problem" explanations for term structure anomalies," Working Paper Series, Issues in Financial Regulation WP-97-07, Federal Reserve Bank of Chicago.
  7. Leippold, Markus & Wu, Liuren, 2002. "Asset Pricing under the Quadratic Class," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(02), pages 271-295, June.
  8. John Y. Campbell & Robert J. Shiller, 1989. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," NBER Working Papers 3153, National Bureau of Economic Research, Inc.
  9. Moraleda, Juan M. & Vorst, Ton C. F., 1997. "Pricing American interest rate claims with humped volatility models," Journal of Banking & Finance, Elsevier, vol. 21(8), pages 1131-1157, August.
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  11. Constantinides, George M, 1992. "A Theory of the Nominal Term Structure of Interest Rates," Review of Financial Studies, Society for Financial Studies, vol. 5(4), pages 531-52.
  12. Tauchen, George E. & Gallant, A. Ronald, 1995. "Which Moments to Match," Working Papers 95-20, Duke University, Department of Economics.
  13. Campbell, John, 1995. "Some Lessons from the Yield Curve," Scholarly Articles 3163264, Harvard University Department of Economics.
  14. 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.
  15. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
  16. Knez, Peter J & Litterman, Robert & Scheinkman, Jose Alexandre, 1994. " Explorations into Factors Explaining Money Market Returns," Journal of Finance, American Finance Association, vol. 49(5), pages 1861-82, December.
  17. Jonathan E. Ingersoll Jr. & Philip H. Dybvig & Stephen A. Ross, 1998. "Long Forward and Zero-Coupon Rates Can Never Fall," Yale School of Management Working Papers ysm45, Yale School of Management.
  18. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
  19. Dong-Hyun Ahn & Robert F. Dittmar, 2002. "Quadratic Term Structure Models: Theory and Evidence," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 243-288, March.
  20. repec:cup:etheor:v:12:y:1996:i:4:p:657-81 is not listed on IDEAS
  21. Markus Leippold & Liuren Wu, 1999. "The Potential Approach to Bond and Currency Pricing," Finance 9903004, EconWPA.
  22. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-92, September.
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  24. David K. Backus, 2001. "Affine Term Structure Models and the Forward Premium Anomaly," Journal of Finance, American Finance Association, vol. 56(1), pages 279-304, 02.
  25. Darrell Duffie & Rui Kan, 1996. "A Yield-Factor Model Of Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(4), pages 379-406.
  26. Geert Bekaert & Robert J. Hodrick, 2000. "Expectations Hypotheses Tests," NBER Working Papers 7609, National Bureau of Economic Research, Inc.
  27. L. C. G. Rogers, 1997. "The Potential Approach to the Term Structure of Interest Rates and Foreign Exchange Rates," Mathematical Finance, Wiley Blackwell, vol. 7(2), pages 157-176.
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  29. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
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