Term-Structure Modelling at the Zero Lower Bound: Implications for Estimating the Forward Term Premium

Abstract

This working paper was written by Tsz-Kin Chung (Tokyo Metropolitan University), Cho-Hoi Hui (Hong Kong Monetary Authority) and Ka-Fai Li (Hong Kong Monetary Authority).

Although the affine Gaussian term-structure model has been a workhorse model in termstructure
modelling, it remains doubtful whether it is an appropriate model in a low interest rate environment. This paper uses an alternative quadratic Gaussian-term structure model which is well known to be as tractable as the affine model and yet is suitable for interest rates close to zero. Compared with the quadratic model under the zero lower bound, we illustrate how the forward term premium can be biased upward under the affine model both theoretically and empirically.

Keywords: term premium; zero lower bound; quadratic Gaussian term-structure model; Bayesian MCMC

JEL Classification: C11, C32, E43, E44, G12