Risk Premia and Volatilities in a Nonlinear Term Structure Model

Review of Finance, Forthcoming

74 Pages Posted: 1 Apr 2013 Last revised: 10 Sep 2016

See all articles by Peter Feldhütter

Peter Feldhütter

Copenhagen Business School

Christian Heyerdahl-Larsen

Indiana University - Kelley School of Business - Department of Finance

Philipp K. Illeditsch

University of Pennsylvania - Finance Department

Date Written: September 1, 2016

Abstract

We introduce a reduced-form term structure model with closed-form solutions for yields where the short rate and market prices of risk are nonlinear functions of Gaussian state variables. The nonlinear model with three factors matches the time-variation in expected excess returns and yield volatilities of U.S. Treasury bonds from 1961 to 2014. Yields and their variances depend on only three factors, yet the model exhibits features consistent with unspanned risk premia (URP) and unspanned stochastic volatility (USV).

Keywords: Nonlinear Term Structure Models, Expected Excess Returns, Stochastic Volatility, Unspanned Risk Premia (URP), Unspanned Stochastic Volatility (USV)

JEL Classification: D51, E43, E52, G12

Suggested Citation

Feldhütter, Peter and Heyerdahl-Larsen, Christian and Illeditsch, Philipp K., Risk Premia and Volatilities in a Nonlinear Term Structure Model (September 1, 2016). Review of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2242280 or http://dx.doi.org/10.2139/ssrn.2242280

Peter Feldhütter

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Christian Heyerdahl-Larsen

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

Philipp K. Illeditsch (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-3477 (Phone)

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