Risk Premia and Volatilities in a Nonlinear Term Structure Model
London Business School
London Business School - Department of Finance
Philipp K. Illeditsch
University of Pennsylvania - Finance Department
September 1, 2016
Review of Finance, Forthcoming
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).
Number of Pages in PDF File: 74
Keywords: Nonlinear Term Structure Models, Expected Excess Returns, Stochastic Volatility, Unspanned Risk Premia (URP), Unspanned Stochastic Volatility (USV)
JEL Classification: D51, E43, E52, G12
Date posted: April 1, 2013 ; Last revised: September 10, 2016
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