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A New Perspective on Gaussian DTSMs
Scott Joslin Massachusetts Institute of Technology Kenneth J. Singleton Stanford Graduate School of Business Haoxiang Zhu Stanford Graduate School of Business October 27, 2009 AFA 2010 Atlanta Meetings Paper Abstract: This paper shows that, within any Gaussian dynamic term structure model (GDTSM), the historical distribution of the pricing factors P is invariant to the imposition of no-arbitrage restrictions, as well as to additional constraints that impinge only on the risk-neutral dynamics of P. It follows that, in these settings, GDTSM-implied forecasts of future values of P are identical to those from an unrestricted vector autoregressive model of P. To establish these results, we develop a novel canonical GDTSM in which the pricing factors are observable portfolios of yields. For our normalization, standard maximum likelihood algorithms converge to the global optimum almost instantaneously. We also extend our analysis to GDTSMs with reduced-rank risk premiums and to those with macroeconomic variables as pricing factors. Empirical estimates and out-of-sample forecasting results are presented for several GDTSMs using data on U.S. Treasury bond yields.
Keywords: Dynamic term structure model, gaussian, estimation JEL Classifications: E43, G12, C13 Working Paper SeriesDate posted: March 23, 2009 ; Last revised: October 29, 2009Suggested CitationContact Information
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