Unifying Gaussian Dynamic Term Structure Models from a Heath-Jarrow-Morton Perspective

Forthcoming, European Journal of Operational Research

43 Pages Posted: 4 Aug 2016 Last revised: 11 Jul 2022

See all articles by Haitao Li

Haitao Li

Cheung Kong Graduate School of Business

Xiaoxia Ye

University of Exeter Business School - Department of Finance

Fan Yu

Claremont McKenna College - Robert Day School of Economics and Finance

Date Written: April 8, 2020

Abstract

In this paper, we show that most existing Gaussian dynamic term structure models (GDTSMs) can be nested as special cases under a unified Heath-Jarrow-Morton (HJM)-based framework of GDTSM construction. Our study provides not only a systematic way to examine the commonality of many seemingly distinct GDTSMs, but also a novel and convenient approach to constructing GDTSMs that are otherwise unavailable or intractable under the traditional approach. In our empirical study using the Euro area forward rates, we conduct a specification analysis based on this novel approach. The analysis reveals that the traditional models impose restrictive constraints limiting their flexibility in capturing key features of the correlations and volatilities of the forward rates.

Keywords: Gaussian Dynamic Term Structure Models, HJM, Finite Dimensional Realizations, Interest Rate Derivatives

JEL Classification: C61, E43, E44, G12

Suggested Citation

Li, Haitao and Ye, Xiaoxia and Yu, Fan, Unifying Gaussian Dynamic Term Structure Models from a Heath-Jarrow-Morton Perspective (April 8, 2020). Forthcoming, European Journal of Operational Research, Available at SSRN: https://ssrn.com/abstract=2817599 or http://dx.doi.org/10.2139/ssrn.2817599

Haitao Li

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Xiaoxia Ye (Contact Author)

University of Exeter Business School - Department of Finance ( email )

Streatham Court
Exeter, EX4 4PU
United Kingdom

HOME PAGE: http://www.xiaoxiaye.me/

Fan Yu

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States
(909)607-3345 (Phone)

HOME PAGE: http://www.cmc.edu/academic/faculty/profile.asp?Fac=553

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