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A New Perspective on Gaussian Dynamic Term Structure ModelsScott JoslinUniversity of Southern California Kenneth J. SingletonStanford University-Graduate School of Business Haoxiang ZhuMassachusetts Institute of Technology (MIT) - Sloan School of Management October 12, 2010 Review of Financial Studies, Forthcoming AFA 2010 Atlanta Meetings Paper Abstract: 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 eff ects of di fferent specifi cations 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, C13 working papers seriesDate posted: March 23, 2009 ; Last revised: October 13, 2010Suggested CitationContact Information
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