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The Dynamics of the Short-Term Interest Rate in the UK

  • Diether Beuermann

    (Inter-American Development Bank)

  • Antonios Antoniou

    (Durham Business School)

  • Alejandro Bernales

    (Inter-American Development Bank)

We estimate and test different continuous-time short-rate models for the UK. The preferred model encompasses both the “level effect” of Chan, Karolyi, Longstaff and Sanders (1992a) and the conditional heteroskedasticity effect of GARCH type models. Our findings suggest that including a GARCH effect in the specification of the conditional variance, almost halves the dependence of volatility on rate levels. We also find weak evidence of mean-reversion and volatility asymmetries in the stochastic behavior of rates. Extensive diagnostic tests suggest that the Constant Elasticity of Variance model of Cox (1975), with an added GARCH effect, provides a reliable description of short-rate dynamics. We demonstrate that the most important feature in short-rate modeling is the correct specification of the conditional variance of changes in rates; suggesting that the conditional mean characterization is of second order.

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File URL: http://128.118.178.162/eps/fin/papers/0512/0512029.pdf
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Paper provided by EconWPA in its series Finance with number 0512029.

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Length: 27 pages
Date of creation: 28 Dec 2005
Date of revision:
Handle: RePEc:wpa:wuwpfi:0512029
Note: Type of Document - pdf; pages: 27
Contact details of provider: Web page: http://128.118.178.162

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  24. Brenner, Robin J. & Harjes, Richard H. & Kroner, Kenneth F., 1996. "Another Look at Models of the Short-Term Interest Rate," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(01), pages 85-107, March.
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