Abstract

http://ssrn.com/abstract=2242280
 
 

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Risk Premia and Volatilities in a Nonlinear Term Structure Model


Peter Feldhütter


London Business School

Christian Heyerdahl-Larsen


London Business School - Department of Finance

Philipp K. Illeditsch


University of Pennsylvania - Finance Department

March 24, 2015


Abstract:     
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 Gaussian factors matches both the time-variation in expected excess returns and yield volatilities of U.S. Treasury bonds from 1961 to 2014. Yields depend on all three factors, yet the model exhibits features consistent with unspanned risk premia (URP) and unspanned stochastic volatility (USV). The probability of a high volatility scenario increases with the monetary experiment and remains high during the Greenspan area, even though volatilities came back down to normal levels.

Number of Pages in PDF File: 60

Keywords: Nonlinear term structure models, affine term structure models, expected excess returns, predictability, stochastic volatility, Unspanned Risk Premia (URP), Unspanned Stochastic Volatility (USV), hidden factors.

JEL Classification: D51, E43, E52, G12


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Date posted: April 1, 2013 ; Last revised: March 26, 2015

Suggested Citation

Feldhütter, Peter and Heyerdahl-Larsen, Christian and Illeditsch, Philipp K., Risk Premia and Volatilities in a Nonlinear Term Structure Model (March 24, 2015). Available at SSRN: http://ssrn.com/abstract=2242280 or http://dx.doi.org/10.2139/ssrn.2242280

Contact Information

Peter Feldhütter
London Business School ( email )
Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
Christian Heyerdahl-Larsen
London Business School - Department of Finance ( email )
Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
Philipp K. Illeditsch (Contact Author)
University of Pennsylvania - Finance Department ( email )
The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-3477 (Phone)

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