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Discussion Paper Details

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Title: Direct Estimation of the Risk Neutral Factor Dynamics of Affine Term Structure Models

Author(s): Dennis Bams and Peter C Schotman

Publication Date: December 1998

Keyword(s): affine models, factor models, Panel Data and Term Structure of Interest Rates

Programme Area(s): Financial Economics

Abstract: This paper proposes a panel data framework for tests of affine models of the term structure of interest rates which cover equilibrium (or endogenous) models as well as extended (or exogenous, evolutionary) models. The econometric model pools yield curve data for different moments in time. Since each cross-sectional yield curve only depends on the risk neutral factor dynamics, the estimator does not involve any assumptions on the price of risk, or on actual interest rate dynamics. In the empirical application one and two factor Gaussian models are tested on US interest rate data. The main empirical results are: (i) that a two-factor model cannot be rejected; (ii) that mean reversion is highly significant; and (iii) that the extended models are 'over-differenced'.

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Bibliographic Reference

Bams, D and Schotman, P. 1998. 'Direct Estimation of the Risk Neutral Factor Dynamics of Affine Term Structure Models'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=2034