Specification Analysis of Affine Term Structure Models

53 Pages Posted: 26 Nov 1998

See all articles by Qiang Dai

Qiang Dai

University of North Carolina (UNC) at Chapel Hill - Finance Area

Kenneth J. Singleton

Stanford University - Graduate School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: October 27, 1998

Abstract

In this paper, we explore the features of affine term structure models that are empirically important for explaining the joint distribution of yields on short- and long-term interest rate swaps. We begin by showing that the family of N-factor affine models can be classified into N+1 non-nested sub-families of models. For each sub-family, we derive a maximal model with the property that every admissible member of this family is equivalent to or a nested special case of our maximal model. Second, using our classification scheme and maximal models, we show that many of the three-factor models in the literature impose potentially strong over-identifying restrictions on the joint distribution of short- and long-term rates. Third, we compute simulated-method-of-moments estimates for several members of one of the four branches of three-factor models, and test the over-identifying restrictions implied by these models. We conclude that many of the extant affine models in the literature fail to describe important features of the distribution of long- and short-term rates. The source of the model misspecification is shown to be overly strong restrictions on the correlations among the state variables. Relaxing these restrictions leads to a model that passes several goodness-of-fit tests over our sample period.

JEL Classification: E43, G12, C51, C52

Suggested Citation

Dai, Qiang and Singleton, Kenneth J., Specification Analysis of Affine Term Structure Models (October 27, 1998). Available at SSRN: https://ssrn.com/abstract=139422 or http://dx.doi.org/10.2139/ssrn.139422

Qiang Dai (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-7182 (Phone)

Kenneth J. Singleton

Stanford University - Graduate School of Business ( email )

Knight Management Center
655 Knight Way
Stanford, CA 94305-7298
United States
650-723-5753 (Phone)

HOME PAGE: http://www.stanford.edu/~kenneths

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