Nonparametric Estimation of Convergence of Interest Rates: Effects on Bond Pricing

43 Pages Posted: 7 Jan 2002

See all articles by Teresa Corzo

Teresa Corzo

Renta 4

Javier Gómez Biscarri

Universitat Pompeu Fabra; Barcelona Graduate School of Economics (Barcelona GSE)

Abstract

We present and estimate, using nonparametric regression techniques, a model of short term interest rate dynamics and use the estimation to value bonds. We study the case of two European countries - Spain and Italy - that belong to EMU, and compare the resulting bond prices of a one factor model with that of a two factor, the second factor being a stochastic mean. The pricing errors for both models are 34% smaller than those reported on the parametric literature. Furthermore, the two factor model, which takes into account the convergence with Europe of the domestic economies, obtains better results than the one factor model. Our findings give strong support to the importance of a correct specification of the volatility of interest rates.

Keywords: Nonparametrics, Interest Rates, Continuous Times, Valuation

JEL Classification: E43, C14

Suggested Citation

Corzo Santamaria, Teresa and Gómez Biscarri, Javier, Nonparametric Estimation of Convergence of Interest Rates: Effects on Bond Pricing. Available at SSRN: https://ssrn.com/abstract=295747 or http://dx.doi.org/10.2139/ssrn.295747

Teresa Corzo Santamaria

Renta 4 ( email )

Pso. de La Habana 63
Madrid
Spain

Javier Gómez Biscarri (Contact Author)

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas, 25-27
Barcelona, E-08005
Spain

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

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