Empirically Confronting Stochastic Singularity: An Application to the Cox, Ingersoll, and Ross Model
Mississippi State University - Department of Finance & Economics
University of Arizona - Department of Finance
April 2, 2008
We just-identify a no-arbitrage term structure model in estimation and then test it using both a classical orthogonality restriction test and a test of conditional predictive ability. We treat the error structure as unmodeled heterogeneity so that the model is estimated without errors, and the statistical question is whether using the model to characterize the dynamics and patterns in historical data is either useful or optimal as a forecasting tool. The data we use are from the transparent Greenspan regime at the Fed (1989-2005), and we also use a rolling estimation format so that regime shifts are not a likely cause of the model's performance. Substantively we find that the model is not a good forecasting device for short rates which in this period are strongly effected by changes in the target Fed Funds rate. For longer term rates, especially at longer horizons where Fed policy has no effect, the model is more informative.
Number of Pages in PDF File: 43
Keywords: Testing Models of Arbitrage, Forecasting Interest Rates
JEL Classification: C90, D40, G10working papers series
Date posted: December 27, 2005 ; Last revised: April 14, 2008
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo4 in 1.719 seconds