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472
Specification Analysis of Affine Term Structure Models
 JOURNAL OF FINANCE
, 2000
"... This paper explores the structural differences and relative goodnessoffits of affine term structure models (ATSMs55). Within the family of ATSMs there is a tradeoff between flexibility in modeling the conditional correlations and volatilities of the risk factors. This tradeoff is formalized by ou ..."
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Cited by 584 (37 self)
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This paper explores the structural differences and relative goodnessoffits of affine term structure models (ATSMs55). Within the family of ATSMs there is a tradeoff between flexibility in modeling the conditional correlations and volatilities of the risk factors. This tradeoff is formalized by our classification of Nfactor affine family into N + 1 nonnested subfamilies of models. Specializing to threefactor ATSMs, our analysis suggests, based on theoretical considerations and empirical evidence, that some subfamilies of ATSMs are better suited than others to explaining historical interest rate behavior.
Term Premia and Interest Rate Forecasts in Affine Models
, 2001
"... I find that the standard class of a#ne models produces poor forecasts of future changes in Treasury yields. Better forecasts are generated by assuming that yields follow random walks. The failure of these models is driven by one of their key features: The compensation that investors receive for faci ..."
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Cited by 445 (11 self)
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I find that the standard class of a#ne models produces poor forecasts of future changes in Treasury yields. Better forecasts are generated by assuming that yields follow random walks. The failure of these models is driven by one of their key features: The compensation that investors receive for facing risk is a multiple of the variance of the risk. This means that risk compensation cannot vary independently of interest rate volatility. I also describe and empirically estimate a class of models that is broader than the standard a#ne class. These "essentially a#ne" models retain the tractability of the usual models, but allow the compensation for interest rate risk to vary independently of interest rate volatility. This additional flexibility proves useful in forming accurate forecasts of future yields. Address correspondence to the University of California, Haas School of Business, 545 Student Services Building #1900, Berkeley, CA 94720. Phone: 5106421435. Email address: du#ee@haas.b...
Testing ContinuousTime Models of the Spot Interest Rate
 Review of Financial Studies
, 1996
"... Different continuoustime models for interest rates coexist in the literature. We test parametric models by comparing their implied parametric density to the same density estimated nonparametrically. We do not replace the continuoustime model by discrete approximations, even though the data are rec ..."
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Cited by 300 (9 self)
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Different continuoustime models for interest rates coexist in the literature. We test parametric models by comparing their implied parametric density to the same density estimated nonparametrically. We do not replace the continuoustime model by discrete approximations, even though the data are recorded at discrete intervals. The principal source of rejection of existing models is the strong nonlinearity of the drift. Around its mean, where the drift is essentially zero, the spot rate behaves like a random walk. The drift then meanreverts strongly when far away from the mean. The volatility is higher when away from the mean. The continuoustime financial theory has developed extensive tools to price derivative securities when the underlying traded asset(s) or nontraded factor(s) follow stochastic differential equations [see Merton (1990) for examples]. However, as a practical matter, how to specify an appropriate stochastic differential equation is for the most part an unanswered question. For example, many different continuoustime The comments and suggestions of Kerry Back (the editor) and an anonymous referee were very helpful. I am also grateful to George Constantinides,
Structural Models of Corporate Bond Pricing: An Empirical Analysis
, 2003
"... This paper empirically tests five structural models of corporate bond pricing: those of Merton (1974), Geske (1977), Leland and Toft (1996), Longsta# and Schwartz (1995), and CollinDufresne and Goldstein (2001). We implement the models using a sample of 182 bond prices from firms with simple capita ..."
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Cited by 233 (5 self)
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This paper empirically tests five structural models of corporate bond pricing: those of Merton (1974), Geske (1977), Leland and Toft (1996), Longsta# and Schwartz (1995), and CollinDufresne and Goldstein (2001). We implement the models using a sample of 182 bond prices from firms with simple capital structures during the period 19861997. The conventional wisdom is that structural models do not generate spreads as high as those seen in the bond market, and true to expectations we find that the predicted spreads in our implementation of the Merton model are too low. However, most of the other structural models predict spreads that are too high on average. Nevertheless, accuracy is a problem, as the newer models tend to severely overstate the credit risk of firms with high leverage or volatility and yet su#er from a spread underprediction problem with safer bonds. The Leland and Toft model is an exception in that it overpredicts spreads on most bonds, particularly those with high coupons. More accurate structural models must avoid features that increase the credit risk on the riskier bonds while scarcely a#ecting the spreads of the safest bonds.
A Nonparametric Model of Term Structure Dynamics and the Market Price of Interest Rate Risk
, 1997
"... This article presents a technique for nonparametrically estimating continuoustime di#usion processes which are observed at discrete intervals. We illustrate the methodology by using daily three and six month Treasury Bill data, from January 1965 to July 1995, to estimate the drift and di#usion of t ..."
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Cited by 207 (5 self)
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This article presents a technique for nonparametrically estimating continuoustime di#usion processes which are observed at discrete intervals. We illustrate the methodology by using daily three and six month Treasury Bill data, from January 1965 to July 1995, to estimate the drift and di#usion of the short rate, and the market price of interest rate risk. While the estimated di#usion is similar to that estimated by Chan, Karolyi, Longsta# and Sanders (1992), there is evidence of substantial nonlinearity in the drift. This is close to zero for low and medium interest rates, but mean reversion increases sharply at higher interest rates.
The Dynamics of Stochastic Volatility: Evidence from Underlying and Option Markets
, 2000
"... This paper proposes and estimates a more general parametric stochastic variance model of equity index returns than has been previously considered using data from both underlying and options markets. The parameters of the model under both the objective and riskneutral measures are estimated simultane ..."
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Cited by 149 (3 self)
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This paper proposes and estimates a more general parametric stochastic variance model of equity index returns than has been previously considered using data from both underlying and options markets. The parameters of the model under both the objective and riskneutral measures are estimated simultaneously. I conclude that the square root stochastic variance model of Heston (1993) and others is incapable of generating realistic returns behavior and find that the data are more accurately represented by a stochastic variance model in the CEV class or a model that allows the price and variance processes to have a timevarying correlation. Specifically, I find that as the level of market variance increases, the volatility of market variance increases rapidly and the correlation between the price and variance processes becomes substantially more negative. The heightened heteroskedasticity in market variance that results generates realistic crash probabilities and dynamics and causes returns to display values of skewness and kurtosis much more consistent with their sample values. While the model dramatically improves the fit of options prices relative to the square root process, it falls short of explaining the implied volatility smile for shortdated options.
Numerical Techniques for Maximum Likelihood Estimation of ContinuousTime Diffusion Processes
, 2002
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Reprojecting Partially Observed Systems with Application to Interest Rate Diffusions from January 5, 1992, to March 31, 1995
, 1996
"... We introduce reprojection as a general purpose technique for characterizing the observable dynamics of a partially observed nonlinear system. System parameters are estimated by method of moments wherein moments implied by the system are matched to moments implied by the transition density for observ ..."
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Cited by 125 (16 self)
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We introduce reprojection as a general purpose technique for characterizing the observable dynamics of a partially observed nonlinear system. System parameters are estimated by method of moments wherein moments implied by the system are matched to moments implied by the transition density for observables that is determined by projecting the data onto its Hermite representation. Reprojection imposes the constraints implied by the system on the transition density and is accomplished by projecting a long simulation of the estimated system onto the Hermite representation. We utilize the technique to assess the dynamics of several diffusion models for the shortterm interest rate that have been proposed and compare them to a new model that has feedback from the interest rate into both the drift and diffusion coefficients of a volatility equation. This effort entails the development of new graphical diagnostics.
Efficient Estimation of Conditional Variance Functions in Stochastic Regression
 Biometrika
, 1998
"... this paper is to derive an ecient fullyadaptive procedure for estimating ..."
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Cited by 120 (7 self)
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this paper is to derive an ecient fullyadaptive procedure for estimating