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Taking Positive Interest Rates Seriously

Author

Listed:
  • Enlin Pan

    (Chicago Partners, LLC)

  • Liuren Wu

    (Zicklin School of Business, Baruch College)

Abstract

We present a dynamic term structure model in which interest rates of all maturities are bounded from below at zero. Positivity and continuity, combined with no arbitrage, result in only one functional form for the term structure with three sources of risk. One dynamic factor controls the level of the interest rate and follows a special two-parameter square-root process under the risk-neutral measure. The two parameters of the process determine the other two sources of risk and act as two static factors. This model has no other parameters to estimate and hence bears no other risks.

Suggested Citation

  • Enlin Pan & Liuren Wu, 2004. "Taking Positive Interest Rates Seriously," Finance 0409013, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:0409013
    Note: Type of Document - pdf; pages: 41
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Term structure; consistency; positivity; quadratic forms;

    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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