Discrete Time Affine Term Structure Models With Squared Gaussian Shocks (DTATSM-SGS)

49 Pages Posted: 3 Apr 2019

Date Written: March 26, 2018

Abstract

The tractability of discrete time affine term structure models (DTATSM) is fully preserved when adding squared Gaussian shocks (SGS) to factor processes. SGS guarantee non-negative factors under parameter restrictions that do not affect market prices of risk. DTATSM-SGS mirror continuous time affine models, but need no Feller conditions. New affine specifications become admissible. Changes of measure can alter not only the conditional mean, but also the conditional covariance of factors and yields through the second-order Esscher transform. This enables DTATSM-SGS to better match US Treasury yields volatility, while the conditional moments of factors and yields are still in closed form. The empirical comparison of DTATSM-SGS and similar models based on autoregressive Gamma processes reveals no clear winner in fitting US Treasury yields.

Keywords: squared Gaussian shocks, discrete time a¢ ne term struc ture models, stochastic volatility, feller condition, a¢ ne autoregressive gamma models

JEL Classification: G12; G13

Suggested Citation

Realdon, Marco, Discrete Time Affine Term Structure Models With Squared Gaussian Shocks (DTATSM-SGS) (March 26, 2018). Available at SSRN: https://ssrn.com/abstract= or http://dx.doi.org/10.2139/ssrn.3350750

Marco Realdon (Contact Author)

Brunel University London ( email )

Economics and Finance Department
Kingstone lane
London, UB7 9PD
United Kingdom

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