Benchmarking Interest Rate Models

Abstract

Interest rate models are a workhorse for risk and asset managers, in particular for those overseeing long term investments. This paper discusses the suitability of admissible Affine Term Structure Model for risk management applications, and presents some results of two models: A parsimonious specification of the A0(3) model of Dai and Singleton, and the Arbitrage-Free Nelson-Siegel model of Christensen, Diebold and Rudebush. We believe they both have sufficient desirable characteristics to be adopted by risk managers of buy-side institutions, such as insurance companies, as a benchmark for their interest rate models.

Keywords: Interest Rates, Affine Term Structure Model, Risk Management, Financial Risks, Diebold-Li, Kalman Filter, Vasicek, multi-variate Vasicek, Gaussian, CIR, Nelson-Siegel, Insurance

JEL Classification: C00