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Estimating the Volatility Structure of an Arbitrage-Free Interest Rate Model Via the Futures Markets

  • Ram Bhar

    (School of Banking & Finance, University of New South Wales)

  • Carl Chiarella

    (School of Finance & Economics, University of Technology, Sydney)

  • Thuy-Duong To

    (School of Finance & Economics, University of Technology, Sydney)

This paper considers a class of Heath-Jarrow-Morton (1992) term structure models, characterized by time deterministic volatilities for the instantaneous forward rate. The bias that arises from using observed futures yields as a proxy for the unobserved instantaneous forward rate is analyzed. The fact that futures contracts can be viewed as derivative instruments on the forward rate is used to determine the likelihood function for futures prices. The likelihood transformation method of Duan (1994) is then used to obtain the full information maximum likelihood estimator for the observable futures prices. The approach is applied to estimate the volatility structure implied by futures contracts traded on the Chicago Mercantile Exchange.

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File URL: http://128.118.178.162/eps/fin/papers/0409/0409003.pdf
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Paper provided by EconWPA in its series Finance with number 0409003.

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Length: 39 pages
Date of creation: 01 Sep 2004
Date of revision:
Handle: RePEc:wpa:wuwpfi:0409003
Note: Type of Document - pdf; pages: 39
Contact details of provider: Web page: http://128.118.178.162

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  8. Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January.
  9. To, Thuy Duong & Carl Chiarella, 2003. "The Jump Component of the Volatility Structure of Interest Rate Futures Markets: An International Comparison," Royal Economic Society Annual Conference 2003 205, Royal Economic Society.
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  16. Brennan, Michael J. & Schwartz, Eduardo S., 1982. "An Equilibrium Model of Bond Pricing and a Test of Market Efficiency," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 17(03), pages 301-329, September.
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  21. Carl Chiarella & Oh Kwon, 2003. "Finite Dimensional Affine Realisations of HJM Models in Terms of Forward Rates and Yields," Review of Derivatives Research, Springer, vol. 6(2), pages 129-155, May.
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