A New Perspective on Gaussian Dynamic Term Structure Models
University of Southern California
Kenneth J. Singleton
Stanford University-Graduate School of Business
Massachusetts Institute of Technology (MIT) - Sloan School of Management
October 12, 2010
Review of Financial Studies, Forthcoming
AFA 2010 Atlanta Meetings Paper
In any canonical Gaussian dynamic term structure model (GDTSM), the conditional forecasts of the pricing factors are invariant to the imposition of no-arbitrage restrictions. This invariance is maintained even in the presence of a variety of restrictions on the factor structure of bond yields. 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 present empirical estimates and out-of-sample forecasts for several GDTSMs using data on U.S. Treasury bond yields. Taken together, our results shed new light on estimation and interpretation of GDTSMs, as well as the effects of different specifications of the risk premiums and the risk-neutral distribution of bond yields on the observed dynamics of the yield curve.
Number of Pages in PDF File: 55
Keywords: dynamic term structure model, no-arbitrage, Gaussian, estimation
JEL Classification: E43, G12, C13working papers series
Date posted: March 23, 2009 ; Last revised: October 13, 2010
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