Tractable Term-Structure Models

53 Pages Posted: 22 Nov 2015 Last revised: 29 Apr 2021

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; Frank Hawkins Kenan Institute of Private Enterprise

Date Written: December 14, 2018

Abstract

We introduce a new framework that facilitates term structure modeling with both positive interest rates and flexible time-series dynamics but that is also tractable, meaning amenable to quick and robust estimation. Using both simulations and U.S. historical data, we compare our approach with benchmark Gaussian, stochastic volatility, and shadow rate models, where the latter enforces positive interest rates. Our approach, which remains arbitrarily close to arbitrage free, offers a more accurate characterization of bond Sharpe ratios due to a better fit of the volatility dynamics and a more efficient estimation of the return dynamics. Further, standard shadow rate and stochastic volatility models exhibit important restrictions that are largely absent in our approach.

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

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)

Frank Hawkins Kenan Institute of Private Enterprise ( email )

Campus Box 3440, The Kenan Center
Chapel Hill, NC 27599-344
United States

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