An Asset Pricing Approach to Testing General Term Structure Models

78 Pages Posted: 26 Mar 2010 Last revised: 24 May 2018

See all articles by Bent Jesper Christensen

Bent Jesper Christensen

Aarhus University; Aarhus University; Aarhus University

Michel van der Wel

Erasmus University Rotterdam; CREATES; ERIM; Tinbergen Institute

Date Written: May 18, 2018

Abstract

We develop a new empirical approach to term structure analysis that allows testing for time-varying risk premiums and arbitrage opportunities in models with both unobservable factors and factors identified as the innovations to observed macroeconomic variables. Factors may play double roles as both covariance-generating common shocks driving yields and determinants of market prices of risk in cross-sectional pricing. The evidence favors time-varying risk prices significantly related to the second Stock-Watson principal component of macroeconomic variables and to changes in the industrial production index. Our preferred specification includes these two observable and two unobservable factors, with the no-arbitrage condition imposed.

Keywords: Arbitrage, Bond Aging Effect, Dynamic Factor Model, Macroeconomic Conditioning Variables, Nonlinear Drift Restriction, State Space Model, Time-Varying Risk Premia, Yield Curve Model

JEL Classification: G12, C32

Suggested Citation

Christensen, Bent Jesper and van der Wel, Michel, An Asset Pricing Approach to Testing General Term Structure Models (May 18, 2018). Available at SSRN: https://ssrn.com/abstract=1578354 or http://dx.doi.org/10.2139/ssrn.1578354

Bent Jesper Christensen (Contact Author)

Aarhus University ( email )

Fuglesangs Alle 4
DK-8210 Aarhus V, 8210
Denmark

Aarhus University ( email )

Fuglesangs Alle 4
DK-8210 Aarhus V, 8210
Denmark

Aarhus University ( email )

Fuglesangs Alle 4
DK-8210 Aarhus V, 8210
Denmark

Michel Van der Wel

Erasmus University Rotterdam ( email )

Burg. Oudlaan 50
Rotterdam, NL 3062 PA
Netherlands

CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

ERIM ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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