A Two-Factor Model of the German Term Structure of Interest Rates

63 Pages Posted: 12 Apr 2003

See all articles by Nuno Cassola

Nuno Cassola

University of Milan Bicocca - CefES; University of Lisbon - CEMAPRE

Jorge Barros Luis

Montepio Bank; Technical University of Lisbon (UTL) - School of Economics and Management

Date Written: March 2001

Abstract

In this paper we show that a two-factor constant volatility model provides an adequate description of the dynamics and shape of the German term structure of interest rates from 1972 up to 1998. The model also provides reasonable estimates of the volatility and term premium curves. Following the conjecture that the two factors driving the German term structure of interest rates represent the ex-ante real interest rate and the expected inflation rate, the identification of one factor with expected inflation is discussed. Our estimates are obtained using a Kalman filter and a maximum likelihood procedure including in the measurement equation both the yields and their volatilities.

Keywords: expectations hypothesis, term premiums, pricing kernels, affine model

JEL Classification: E43, G12

Suggested Citation

Cassola, Nuno and Barros Luis, Jorge, A Two-Factor Model of the German Term Structure of Interest Rates (March 2001). Available at SSRN: https://ssrn.com/abstract=356020

Nuno Cassola (Contact Author)

University of Milan Bicocca - CefES ( email )

Milan
Italy

University of Lisbon - CEMAPRE ( email )

Lisbon
Portugal

Jorge Barros Luis

Montepio Bank ( email )

Rua do Carmo, No. 42, 6.andar
Lisbon, 1200-094
Portugal

Technical University of Lisbon (UTL) - School of Economics and Management ( email )

Lisbon
Portugal

HOME PAGE: http://www.iseg.utl.pt

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