A Multifactor, Nonlinear, Continuous-Time Model of Interest Rate Volatility

43 Pages Posted: 13 Aug 1999

See all articles by Jacob Boudoukh

Jacob Boudoukh

Interdisciplinary Center (IDC) Herzliyah; AQR Capital Management, LLC

Richard Stanton

University of California, Berkeley - Haas School of Business

Matthew P. Richardson

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); AQR Capital Management, LLC

Robert Whitelaw

New York University; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: June 17, 1999

Abstract

This paper presents a general, nonlinear version of existing multifactor models, such as Longstaff and Schwartz (1992). The novel aspect of our approach is that rather than choosing the model parameterization out of "thin air," our processes are generated from the data using approximation methods for multifactor continuous-time Markov processes. In applying this technique to the short- and long-end of the term structure for a general two-factor diffusion process for interest rates, a major finding is that the volatility of interest rates is increasing in the level of interest rates only for sharply upward sloping term structures. In fact, the slope of the term structure plays a larger role in determining the magnitude of the diffusion coefficient. As an application, we analyze the model's implications for the term structure of term premiums.

JEL Classification: G12, E43, G14

Suggested Citation

Boudoukh, Jacob and Stanton, Richard H. and Richardson, Matthew P. and Whitelaw, Robert F., A Multifactor, Nonlinear, Continuous-Time Model of Interest Rate Volatility (June 17, 1999). Available at SSRN: https://ssrn.com/abstract=171050 or http://dx.doi.org/10.2139/ssrn.171050

Jacob Boudoukh

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Richard H. Stanton

University of California, Berkeley - Haas School of Business ( email )

Haas School of Business
545 Student Services Building #1900
Berkeley, CA 94720-1900
United States
(510) 642-7382 (Phone)
(510) 643-1412 (Fax)

Matthew P. Richardson

New York University (NYU) - Department of Finance ( email )

44 West 4th Street
Suite 9-190
New York, NY 10012-1126
United States
212-998-0349 (Phone)
212-995-4233 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Robert F. Whitelaw (Contact Author)

New York University ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0338 (Phone)
212-995-4233 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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