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

Author

Listed:
  • Diether Beuermann

    (Inter-American Development Bank)

  • Antonios Antoniou

    (Durham Business School)

  • Alejandro Bernales

    (Inter-American Development Bank)

Abstract

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.

Suggested Citation

  • Diether Beuermann & Antonios Antoniou & Alejandro Bernales, 2005. "The Dynamics of the Short-Term Interest Rate in the UK," Finance 0512029, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:0512029
    Note: Type of Document - pdf; pages: 27
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    File URL: https://econwpa.ub.uni-muenchen.de/econ-wp/fin/papers/0512/0512029.pdf
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    References listed on IDEAS

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    Cited by:

    1. Nowman, K.B. & Yahia, B.B.H., 2008. "Euro and FIBOR interest rates: A continuous time modelling analysis," International Review of Financial Analysis, Elsevier, vol. 17(5), pages 1029-1035, December.
    2. Ruiz-Porras, Antonio & Perez-Sicairos, Rene Benjamin, 2010. "Un modelo de tres factores con un parámetro de sensibilidad de mercado para estimar la dinámica de la tasa corta: Una aplicación para la tasa de fondeo gubernamental de México
      [A three-factor model
      ," MPRA Paper 26631, University Library of Munich, Germany.

    More about this item

    Keywords

    Short-rate; level effect; GARCH effect.;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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