Observational Equivalence of Discrete String Models and Market Models

9 Pages Posted: 4 Oct 2001  

Jeroen Kerkhof

Lehman Brothers International, Europe

Antoon Pelsser

Maastricht University; Netspar

Multiple version iconThere are 2 versions of this paper

Date Written: October 5, 2001

Abstract

In this paper we show that contrary to the claim made in Longstaff, Santa-Clara, and Schwartz (2000a) and Longstaff, Santa-Clara, and Schwartz (2000b) discrete string models are not more parsimonious than market models. In fact, they are found to be observationally equivalent. We derived that for the estimation of both a K-factor discrete string model and a K-factor Libor market model for N forward rates the number of parameters needed to be estimated equals NK-K(K-1)/2 and not K(K+1)/2 and NK, respectively. We do believe that from an economic point of view the interpretation of the decomposition of the covariance (or correlation) matrix in the discrete string model deserves preference over the market model.

Keywords: String model, market model

JEL Classification: G12

Suggested Citation

Kerkhof, Jeroen and Pelsser, Antoon, Observational Equivalence of Discrete String Models and Market Models (October 5, 2001). Available at SSRN: https://ssrn.com/abstract=286258 or http://dx.doi.org/10.2139/ssrn.286258

F.L. Jeroen Kerkhof (Contact Author)

Lehman Brothers International, Europe ( email )

25 Bank Street
30th Floor
London E14 5LE
United Kingdom

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

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