Tractable Term Structure Models

54 Pages Posted: 22 Nov 2015 Last revised: 1 Aug 2019

See all articles by Bruno Feunou

Bruno Feunou

Bank of Canada

Jean-Sebastien Fontaine

Bank of Canada

Anh Le

Penn State University Smeal College of Business

Christian T. Lundblad

University of North Carolina Kenan-Flagler Business School

Date Written: December 14, 2018

Abstract

Interest rate forecasting remains vexing because of the lower bound. A few tractable models are available, but they offer limited or restrictive volatility dynamics. In response, we build on the popular dynamic Nelson-Siegel approach to greatly expand the space of term-structure models that are tractable and with realistic dynamics. Our approach directly specifies closed-form bond prices and delivers a rich family of non-linear models that, importantly, we can transform into the linear space for efficient, instantaneous estimation. Pragmatic real-time interest rate forecasting is then feasible for non-linear models in a manner very challenging for harder-to-estimate traditional non-linear no-arbitrage models. As a practically relevant example, we implement a tractable specification that incorporates the lower bound and time-varying volatility, but improves the forecast accuracy of bond returns, volatilities, and Sharpe ratios.

Keywords: Term-Structure, Lower Bound, No-Arbitrage, Forecasting

JEL Classification: G12

Suggested Citation

Feunou, Bruno and Fontaine, Jean-Sebastien and Le, Anh and Lundblad, Christian T., Tractable Term Structure Models (December 14, 2018). Available at SSRN: https://ssrn.com/abstract=2693568 or http://dx.doi.org/10.2139/ssrn.2693568

Bruno Feunou

Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada
613-782-8302 (Phone)

HOME PAGE: http://kamkui.net/

Jean-Sebastien Fontaine (Contact Author)

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

HOME PAGE: http://www.jean-sebastienfontaine.com

Anh Le

Penn State University Smeal College of Business ( email )

Business Building
University Park, PA 16801
United States

Christian T. Lundblad

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-8441 (Phone)

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