IDEAS home Printed from https://ideas.repec.org/p/yor/yorken/06-15.html
   My bibliography  Save this paper

The Target Rate and Term Structure of Interest Rates

Author

Abstract

This paper presents a tractable bond valuation model, which further develops the approach proposed by Piazzesi (2005). The short term inter-bank interest rate is equal to the target rate set by the central bank plus a spread. Bond yields are driven by the intensities that determine the probabilities that the central bank may raise or cut the target interest rate. Unlike in Piazzesi (2005), negative intensities have a convenient interpretation and do not complicate estimation, and two accurate approximations to the bond pricing equation provide new closed form solutions for discount bond prices that require no numerical integration. Unlike in Piazzesi the target interest rate can be constrained to be non-negative. Yields, especially long term ones, decrease when the central bank is expected to decide more frequent and/or larger average future changes in the target interest rate. The model lends itself to easy calibration and estimation.

Suggested Citation

  • Marco Realdon, 2006. "The Target Rate and Term Structure of Interest Rates," Discussion Papers 06/15, Department of Economics, University of York.
    • Handle: RePEc:yor:yorken:06/15
    as

    Download full text from publisher

    File URL: https://www.york.ac.uk/media/economics/documents/discussionpapers/2006/0615.pdf
    File Function: Main text
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Monika Piazzesi, 2005. "Bond Yields and the Federal Reserve," Journal of Political Economy, University of Chicago Press, vol. 113(2), pages 311-344, April.
    2. Qiang Dai & Kenneth J. Singleton, 2000. "Specification Analysis of Affine Term Structure Models," Journal of Finance, American Finance Association, vol. 55(5), pages 1943-1978, October.
    3. Sun, Licheng, 2005. "Regime shifts in interest rate volatility," Journal of Empirical Finance, Elsevier, vol. 12(3), pages 418-434, June.
    4. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    5. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
    6. Michael Johannes, 2004. "The Statistical and Economic Role of Jumps in Continuous-Time Interest Rate Models," Journal of Finance, American Finance Association, vol. 59(1), pages 227-260, February.
    7. Christian Gourieroux & Alain Monfort & Vassilis Polimenis, 2002. "Affine Term Structure Models," Working Papers 2002-49, Center for Research in Economics and Statistics.
    8. Qiang Dai & Kenneth Singleton, 2003. "Term Structure Dynamics in Theory and Reality," The Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 631-678, July.
    9. Sun, Tong-sheng, 1992. "Real and Nominal Interest Rates: A Discrete-Time Model and Its Continuous-Time Limit," The Review of Financial Studies, Society for Financial Studies, vol. 5(4), pages 581-611.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Jiang, George & Yan, Shu, 2009. "Linear-quadratic term structure models - Toward the understanding of jumps in interest rates," Journal of Banking & Finance, Elsevier, vol. 33(3), pages 473-485, March.
    2. Realdon, Marco, 2006. "Quadratic term structure models in discrete time," Finance Research Letters, Elsevier, vol. 3(4), pages 277-289, December.
    3. Chen, Bin & Song, Zhaogang, 2013. "Testing whether the underlying continuous-time process follows a diffusion: An infinitesimal operator-based approach," Journal of Econometrics, Elsevier, vol. 173(1), pages 83-107.
    4. Fan, Longzhen & Johansson, Anders C., 2010. "China's official rates and bond yields," Journal of Banking & Finance, Elsevier, vol. 34(5), pages 996-1007, May.
    5. Alain Monfort & Fulvio Pegoraro, 2007. "Switching VARMA Term Structure Models - Extended Version," Working Papers 2007-19, Center for Research in Economics and Statistics.
    6. repec:wyi:journl:002109 is not listed on IDEAS
    7. Qiang Dai & Kenneth Singleton, 2003. "Term Structure Dynamics in Theory and Reality," The Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 631-678, July.
    8. Huse, Cristian, 2011. "Term structure modelling with observable state variables," Journal of Banking & Finance, Elsevier, vol. 35(12), pages 3240-3252.
    9. Michael Gallmeyer & Burton Hollifield & Francisco Palomino & Stanley Zin, 2017. "Term Premium Dynamics and the Taylor Rule," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 7(04), pages 1-39, December.
    10. Driessen, Joost & Melenberg, Bertrand & Nijman, Theo, 2005. "Testing affine term structure models in case of transaction costs," Journal of Econometrics, Elsevier, vol. 126(1), pages 201-232, May.
    11. Hans Dewachter & Marco Lyrio & Konstantijn Maes, 2006. "A joint model for the term structure of interest rates and the macroeconomy," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(4), pages 439-462, May.
    12. Shu Wu, 2007. "Interest Rate Risk and the Forward Premium Anomaly in Foreign Exchange Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 423-442, March.
    13. Hordahl, Peter & Tristani, Oreste & Vestin, David, 2006. "A joint econometric model of macroeconomic and term-structure dynamics," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 405-444.
    14. Marco Realdon, 2007. "Extended-Gaussian Term Structure Models and Credit Risk Applications," Discussion Papers 07/27, Department of Economics, University of York.
    15. Grishchenko, Olesya V. & Vanden, Joel M. & Zhang, Jianing, 2016. "The informational content of the embedded deflation option in TIPS," Journal of Banking & Finance, Elsevier, vol. 65(C), pages 1-26.
    16. Yu, Wei-Choun & Zivot, Eric, 2011. "Forecasting the term structures of Treasury and corporate yields using dynamic Nelson-Siegel models," International Journal of Forecasting, Elsevier, vol. 27(2), pages 579-591.
    17. Beliaeva, Natalia & Nawalkha, Sanjay, 2012. "Pricing American interest rate options under the jump-extended constant-elasticity-of-variance short rate models," Journal of Banking & Finance, Elsevier, vol. 36(1), pages 151-163.
    18. Andrew Ang & Geert Bekaert & Min Wei, 2008. "The Term Structure of Real Rates and Expected Inflation," Journal of Finance, American Finance Association, vol. 63(2), pages 797-849, April.
    19. J.Marcelo Ochoa, 2006. "An interpretation of an affine term structure model of Chile," Estudios de Economia, University of Chile, Department of Economics, vol. 33(2 Year 20), pages 155-184, December.
    20. Wolfgang Lemke & Deutsche Bundesbank, 2006. "Term Structure Modeling and Estimation in a State Space Framework," Lecture Notes in Economics and Mathematical Systems, Springer, number 978-3-540-28344-7, December.
    21. Gallmeyer, Michael F. & Hollifield, Burton & Zin, Stanley E., 2005. "Taylor rules, McCallum rules and the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 52(5), pages 921-950, July.

    More about this item

    Keywords

    Bond valuation; target interest rate; closed form solution; yield curve; central banker's meeting;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:yor:yorken:06/15. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Paul Hodgson (email available below). General contact details of provider: https://edirc.repec.org/data/deyoruk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.