In this paper, we characterize, interpret, and test the over-identifying restrictions imposed in affine models of the term-structure. "We begin by showing, using the classification scheme proposed by Dai, Liu, and Singleton [10] for general affine diffusions, that the family of N-factor models can be classified into N + 1 non-nested sub-families of models. For each subfamily, we derive a canonical model with the property that every admissible member of this family is equivalent to or a nested special case of our canonical model. Second, using our classification scheme and canonical models, we show that many of the three-factor models in the literature impose potentially strong over-identifying restrictions, and we completely characterize these restrictions. Finally, we compute simulated-method-of-moments estimates for several members of the sub-family of three-factor models that nest the "benchmark" model of Chen [8], and test the over-identifying restrictions on the joint distribution...

We examine the empirical evidence on the expectations hypothesis of the term structure of interest rates in the United States, the United Kingdom, and Germany using the Campbell-Shiller (1991) regressions and a vector-autoregressive methodology. We argue that anomalies in the U.S. term structure, documented by Campbell and Shiller (1991), may be due to a generalized peso problem in which a high-interest rate regime occuued less frequently in the sample of U.S. data than was rationally anticipated. We formalize this idea as a regime-switching model of short-term interest rates estimated with data from seven countries. Technically, this model extends recent research on regime-switching models with state-dependent transitions to a cross-sectional setting. Use of the small sample distributions generated by the regime-switching model for inference considerably weakens the evidence against the expectations hypothesis, but it remains somewhat implausible that our data-generating process produced the U.S. data. However, a model that combines moderate time-variation in term premiums with peso-problem effects is largely consistent with term structure

We develop a term structure model where the short interest rate and the market price of risks are subject to discrete regime shifts. Empirical evidence from efficient method of moments estimation provides considerable support for the regime shifts model. Standard models, which include affine specifications with up to three factors, are sharply rejected in the data. Our diagnostics show that only the regime shifts model can account for the well-documented violations of the expectations hypothesis, the observed conditional volatility, and the conditional correlation across yields. We find that regimes are intimately related to business cycles. MANY PAPERS DOCUMENT THAT THE UNIVARIATE short interest rate process can be reasonably well modeled in the time series as a regime switching process ~see Hamilton ~1988!, Garcia and Perron ~1996!!. In addition to this statistical evidence, there are economic reasons as well to believe that regime shifts are important to understanding the behavior of the entire yield curve. For example, business cycle expansion and contraction “regimes ” potentially

This paper is a critical survey of models designed for pricing fixed income securities and their associated term structures of market yields. Our primary focus is on the interplay between the theoretical specification of dynamic term structure models and their empirical fit to historical changes in the shapes of yield curves. We begin by overviewing the dynamic term structure models that have been fit to treasury or swap yield curves and in which the risk factors follow diffusions, jump-diffusion, or have “switching regimes. ” Then the goodness-of-fits of these models are assessed relative to their abilities to: (i) match linear projections of changes in yields onto the slope of the yield curve; (ii) match the persistence of conditional volatilities, and the shapes of term structures of unconditional volatilities, of yields; and (iii) to reliably price caps, swaptions, and other fixed-income derivatives. For the case of defaultable securities we explore the relative fits to historical yield spreads. 1

We derive closed-form solutions for asset prices in an RBC economy. The equations are based on a log-linear solution of the RBC model and allow a clearer understanding of the determination of risk premia in models with production. We demonstrate not only why the premium of equity over the risk-free rate is small but also why the premium of equity over a real long-term bond is small and often negative. In particular, risk premia for equity and long real bonds are negative when technology shocks are permanent. Recently, a growing literature has explored the asset pricing implications of real business cycle (RBC) models. Examples are Rouwenhorst (1995), Jermann (1998) and Boldrin et al. (1995). 1 From a methodological point of view, models with production allow a more realistic modelling of consumption and dividends than do the pure exchange economies of Lucas (1978). However, explaining the behaviour of asset prices in production economies is also more challenging. For example, in an exchange economy, an increase in risk premia can be obtained by increasing risk aversion. This is not necessarily true in production economies, since agents can choose a smoother consumption path by substituting between

We provide a user’s guide to “exotic ” preferences: nonlinear time aggregators, departures from expected utility, preferences over time with known and unknown probabilities, risksensitive and robust control, “hyperbolic ” discounting, and preferences over sets (“temptations”). We apply each to a number of classic problems in macroeconomics and finance, including consumption and saving, portfolio choice, asset pricing, and Pareto optimal allocations.

No-arbitrage term structure models impose cross-sectional restrictions among yields and can be used to impose dynamic restrictions on risk compensation. This paper evaluates the importance of these restrictions when using the term structure to forecast future bond yields. It concludes that no cross-sectional restrictions are helpful, because cross-sectional properties of yields are easy to infer with high precision. Dynamic restrictions are useful, but can be imposed without relying on the no-arbitrage structure. In practice, the most important dynamic restriction is that the first principal component of Treasury yields follows a random walk. A simple model built around this assumption produces out-of-sample forecasts that are more accurate than those of a variety of alternative dynamic models.

SES-0922338. The views expressed herein are those of the author(s) and do not necessarily reflect

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Inspecting the mechanism: closed-form solutions for