Bilinear Term Structure Model
University of Toronto - Department of Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO); Ecole Nationale de la Statistique et de l'Administration Economique (ENSAE); National Bureau of Economic Research (NBER)
National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST); National Bureau of Economic Research (NBER); Maastricht University
September 14, 2010
Mathematical Finance, Vol. 21, Issue 1, pp. 1-19, 2010
The Gaussian Affine Term Structure Model (ATSM) introduced by Duffie and Kan is often used in finance to price derivatives written on interest rates or to compute the reserve to hedge a portfolio of credits (CreditVaR), and in macroeconomic applications to study the links between real activity and financial variables. However, a standard three-factor ATSM, for instance, implies a deterministic affine relationship between any set of four rates, with different times-to-maturity, and these relationships are not observed in practice. In this paper, we introduce a new class of affine term structure models, called Bilinear Term Structure Model (BTSM). This extension breaks down the deterministic relationships between rates in structural factor models by introducing lagged factor values, and the linear dependence by considering quadratic effects of the factors.
Number of Pages in PDF File: 19
Keywords: affine term structure, quadratic term structure, monetary policy, credit risk, Wishart process, bilinear process
Date posted: January 1, 2011
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