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Design and Estimation of Quadratic Term Structure Models

Author

Listed:
  • Markus Leippold

    (University of Zurich)

  • Liuren Wu

    (Fordham University)

Abstract

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.

Suggested Citation

  • Markus Leippold & Liuren Wu, 2002. "Design and Estimation of Quadratic Term Structure Models," Finance 0207014, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:0207014
    Note: Type of Document - pdf; prepared on MikTex; to print on postscript; pages: 49 ; figures: included. produced via dvipdfm
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. 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.
    2. Peng Cheng & Olivier Scaillet, 2002. "Linear-Quadratic Jump-Diffusion Modeling with Application to Stochastic Volatility," FAME Research Paper Series rp67, International Center for Financial Asset Management and Engineering.
    3. Marco Realdon, 2007. "A Two Factor Black-Karasinski Credit Default Swap Pricing Model (forthcoming in the Icfai Journal of Derivatives Markets, Vol IV, No 4, October 2007; all copyrights rest with the Icfai University Pres," Discussion Papers 07/25, Department of Economics, University of York.
    4. Qiang Dai & Kenneth Singleton, 2003. "Term Structure Dynamics in Theory and Reality," Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 631-678, July.
    5. Realdon, Marco, 2006. "Quadratic term structure models in discrete time," Finance Research Letters, Elsevier, vol. 3(4), pages 277-289, December.
    6. Li Chen & H. Vincent Poor, 2003. "Markovian Quadratic Term Structure Models For Risk-free And Defaultable Rates," Finance 0303008, EconWPA.
    7. Andrew Ang & Jean Boivin & Sen Dong & Rudy Loo-Kung, 2011. "Monetary Policy Shifts and the Term Structure," Review of Economic Studies, Oxford University Press, vol. 78(2), pages 429-457.
    8. Marco Realdon, 2007. "Extended-Gaussian Term Structure Models and Credit Risk Applications," Discussion Papers 07/27, Department of Economics, University of York.
    9. Samson Assefa, 2007. "Calibration and Pricing in a Multi-Factor Quadratic Gaussian Model," Research Paper Series 197, Quantitative Finance Research Centre, University of Technology, Sydney.
    10. Satoshi Yamashita & Toshinao Yoshiba, 2011. "Analytical Solution for the Loss Distribution of a Collateralized Loan under a Quadratic Gaussian Default Intensity Process," IMES Discussion Paper Series 11-E-20, Institute for Monetary and Economic Studies, Bank of Japan.
    11. Dai, Qiang & Singleton, Kenneth J., 2003. "Fixed-income pricing," Handbook of the Economics of Finance,in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 20, pages 1207-1246 Elsevier.
    12. Marco Realdon, 2006. "Equity Valuation Under Stochastic Interest Rates," Discussion Papers 06/12, Department of Economics, University of York.
    13. Kentaro Kikuchi, 2012. "Design and Estimation of a Quadratic Term Structure Model with a Mixture of Normal Distributions," IMES Discussion Paper Series 12-E-08, Institute for Monetary and Economic Studies, Bank of Japan.
    14. Li Chen & H. Vincent Poor, 2003. "Credit Risk Modeling and the Term Structure of Credit Spreads," Finance 0312009, EconWPA.
    15. Don H Kim, 2007. "Spanned stochastic volatility in bond markets: a reexamination of the relative pricing between bonds and bond options," BIS Working Papers 239, Bank for International Settlements.
    16. Enlin Pan & Liuren Wu, 2004. "Taking Positive Interest Rates Seriously," Finance 0409013, EconWPA.
    17. Feng Zhao & Robert Jarrow & Haitao Li, 2004. "Interest Rate Caps Smile Too! But Can the LIBOR Market Models Capture It?," Econometric Society 2004 North American Winter Meetings 431, Econometric Society.
    18. Don H. Kim, 2008. "Zero bound, option-implied PDFs, and term structure models," Finance and Economics Discussion Series 2008-31, Board of Governors of the Federal Reserve System (U.S.).
    19. Massoud Heidari & Liuren Wu, 2002. "Term Structure of Interest Rates, Yield Curve Residuals, and the Consistent Pricing of Interest Rates and Interest Rate Derivatives," Finance 0207010, EconWPA, revised 10 Sep 2002.

    More about this item

    Keywords

    quadratic model; term structure; positive interest rates; humps; expectation hy­pothesis; GMM; caps and floors.;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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