What Does a Term Structure Model Imply About Very Long-Term Interest Rates?

37 Pages Posted: 29 Jan 2014 Last revised: 4 Jun 2020

See all articles by Anne Balter

Anne Balter

Tilburg University; Netspar

Antoon Pelsser

Maastricht University; Netspar

Peter C. Schotman

Maastricht University - Department of Finance

Date Written: September 24, 2016

Abstract

We address two empirical issues related to the long end of the yield curve based on euro swap rates. First, for maturities longer than 20 years we find evidence for an `excess' downward slope that cannot be explained by convexity. Second, volatility at the very long end of the yield curve is larger than predicted by no-arbitrage models. We construct a model-based arbitrage-free extrapolation of the yield-curve and compare it to the regulatory discount curve. Because of near-zero mean reversion, there is no convergence towards an `ultimate forward rate' and convexity effects cause the arbitrage-free extrapolations to have slightly downward sloping curves. The low level of mean-reversion also implies that the volatility of long-term rates does not decline relative to the 20-year volatility. Therefore, we conclude that the mean-reversion and resulting smoothing adopted by the regulatory curve is much too strong.

Keywords: term structure models, parameter uncertainty, extrapolation, insurance supervision

JEL Classification: G23, G12, C58

Suggested Citation

Balter, Anne and Pelsser, Antoon A. J. and Schotman, Peter C., What Does a Term Structure Model Imply About Very Long-Term Interest Rates? (September 24, 2016). Available at SSRN: https://ssrn.com/abstract=2386699 or http://dx.doi.org/10.2139/ssrn.2386699

Anne Balter (Contact Author)

Tilburg University ( email )

P.O. Box 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Antoon A. J. Pelsser

Maastricht University ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands

HOME PAGE: http://https://sites.google.com/site/apelsseraca/

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Peter C. Schotman

Maastricht University - Department of Finance ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands
+31 43 388 3862 (Phone)
+31 43 388 4875 (Fax)

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