A Tale of Two Yield Curves: Modeling the Joint Term Structure of Dollar and Euro Interest Rates

39 Pages Posted: 23 Mar 2008

See all articles by Alexei V. Egorov

Alexei V. Egorov

West Virginia University - College of Business & Economics

Haitao Li

University of Michigan - Stephen M. Ross School of Business; Cheung Kong Graduate School of Business; Cheung Kong Graduate School of Business

David T. Ng

Johnson College of Business; Cornell SC Johnson College of Business

Abstract

Modeling the joint term structure of interest rates in the United States and the European Union, the two largest economies in the world, is extremely important in international finance. In this paper, we provide both theoretical and empirical analysis of multi-factor joint affine term structure models for dollar and euro interest rates. In particular, we provide a systematic classification of multi-factor joint affine term structure models similar to that of Dai and Singleton (2000). A principal component analysis of daily dollar and euro interest rates reveals four factors in the data. We estimate four-factor joint affine term structure models using the approximate maximum likelihood method of Ait-Sahalia (2002, 2007) and compare the in-sample and out-of-sample performances of these models using some of the latest nonparametric methods. We find that a new four-factor model with two common and two local factors captures the joint term structure dynamics in the U.S. and the E.U. reasonably well.

Keywords: Affine term structure models, International term structure models, Approximate Maximum Likelihood, LIBOR, Euribor, Specification analysis of term structure of interest rates, Out-of-sample model evaluation.

JEL Classification: C4, C5, G1

Suggested Citation

Egorov, Alexei V. and Li, Haitao and Ng, David T., A Tale of Two Yield Curves: Modeling the Joint Term Structure of Dollar and Euro Interest Rates. Journal of Econometrics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1112127

Alexei V. Egorov

West Virginia University - College of Business & Economics ( email )

Morgantown, WV 26506-6025
United States

Haitao Li (Contact Author)

University of Michigan - Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-615-5475 (Phone)

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

David T. Ng

Johnson College of Business ( email )

301G Warren Hall, Cornell University
Ithaca, NY 14850-1967
United States
6072550145 (Phone)

Cornell SC Johnson College of Business ( email )

Ithaca, NY 14850
United States

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