A Note on the Dai-Singleton Canonical Representation of Affine Term Structure Models
Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute
Robert L. Kimmel
Ohio State University (OSU) - Department of Finance
Fisher College of Business Working Paper No. 2007-03-005
Charles A. Dice Working Paper No. 2007-2
Dai and Singleton (2000) study a class of term structure models for interest rates that specify the instantaneous interest rate as an affine combination of the components of an N-dimensional affine diffusion process. Observable quantities of such models are invariant under regular affine transformations of the underlying diffusion process. And in their canonical form, the models in Dai and Singleton (2000) are based on diffusion processes with diagonal diffusion matrices. This motivates the following question: Can the diffusion matrix of an affine diffusion process always be diagonalized by means of a regular affine transformation?
We show that if the state space of the diffusion is of the form D = Rm+ x RN - m for integers 0 <= m <= N satisfying m <= 1 or m >= N - 1, then there exists a regular affine transformation of D onto itself that diagonalizes the diffusion matrix. On the other hand, we provide examples of affine diffusion processes with state space R2+ x R2 whose diffusion matrices cannot be diagonalized through regular affine transformation.
Number of Pages in PDF File: 11
Keywords: affine diffusion processes, affine transformations, diagonal diffusion matrices
JEL Classification: G12, G13working papers series
Date posted: February 26, 2007 ; Last revised: September 27, 2010
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