Risk premia and volatilities in a nonlinear term structure model

Feldhutter, P and Heyerdahl-Larsen, C and Illeditsch, P (2016) Risk premia and volatilities in a nonlinear term structure model. Review of Finance. ISSN 1572-3097

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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 U.S. 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).

Item Type: Article
Additional Information: © 2016 European Finance Association
Subjects: R > Rate of return
F > Financial risk
B > Bonds
T > Term structure of interest rates
Subject Areas: Finance
DOI: 10.1093/rof/rfw052
Date Deposited: 01 Nov 2016 18:31
Last Modified: 08 Sep 2017 14:29
URI: http://lbsresearch.london.edu/id/eprint/568

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