Abstract
We introduce a reduced-form term structure model with closed-form solutions for yields where the short rate and market prices of risk are nonlinear functions of Gaussian state variables. The nonlinear model with three factors matches the time-variation in expected excess returns and yield volatilities of US Treasury bonds from 1961 to 2014. Yields and their variances depend on only three factors, yet the model exhibits features consistent with Unspanned Risk Premia (URP) and Unspanned Stochastic Volatility (USV).
Original language | English |
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Journal | Review of Finance |
Volume | 22 |
Issue number | 1 |
Pages (from-to) | 337–380 |
Number of pages | 44 |
ISSN | 1572-3097 |
DOIs | |
Publication status | Published - Feb 2018 |
Keywords
- Nonlinear term structure models
- Expected excess returns
- Stochastic volatility
- Unspanned risk premia
- Unspanned stochastic volatility