A New Taxonomy of the Dynamic Term Structure Models

44 Pages Posted: 11 Sep 2008 Last revised: 20 Sep 2010

See all articles by Sanjay K. Nawalkha

Sanjay K. Nawalkha

University of Massachusetts Amherst - Isenberg School of Management

Natalia Beliaeva

Suffolk University - Department of Finance

Gloria M. Soto

University of Murcia - Faculty of Business and Economics

Date Written: September 16, 2010

Abstract

This paper gives a new taxonomy of dynamic term structure models that classifies all existing TSMs as either fundamental models or preference-free single-plus, double-plus, and triple-plus models. We exemplify the new taxonomy by considering preference-free versions of some well-known fundamental short rate models. Single-plus extensions of the fundamental models are shown to be both time-homogeneous and preference-free - two characteristics which do not simultaneously hold under any existing class of TSMs. Though the analytical apparatus for pricing fixed income securities is identical under fundamental models and single-plus models, the latter models are consistent with general non-linear forms of MPRs which may also depend upon an arbitrary set of state variables, leading to better estimates of risk-neutral parameters. The preference-free double-plus and triple-plus extensions of the fundamental models are similar to the Heath, Jarrow, and Morton [1992] models, in that time-inhomogeneous drifts and volatilities are used as "smoothing variables" to fit the initial bond prices and initial term structure of volatilities, respectively.

Keywords: Affine models, quadratic models, HJM models, LIBOR/SABR models, Single-Plus models, Double-Plus models, Triple-Plus models, new taxonomy

JEL Classification: G11, G12, G13

Suggested Citation

Nawalkha, Sanjay K. and Beliaeva, Natalia and Soto, Gloria M., A New Taxonomy of the Dynamic Term Structure Models (September 16, 2010). Available at SSRN: https://ssrn.com/abstract=1265286 or http://dx.doi.org/10.2139/ssrn.1265286

Sanjay K. Nawalkha (Contact Author)

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States
413-687-2561 (Phone)

Natalia Beliaeva

Suffolk University - Department of Finance ( email )

8 Ashburton Place-Beacon Hill
Boston, MA 02108-2770
United States

Gloria M. Soto

University of Murcia - Faculty of Business and Economics ( email )

Spain

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