The Dynamics of Short-Term Interest Rate Volatility Reconsidered
Posted: 15 Sep 1999
Date Written: August 1994
In this paper we present and estimate a model of short-term interest rate volatility, that encompasses both the level effect of Chan, Karolyi, Longstaff and Sanders (1992) and the conditional heteroskedasticity effect of the GARCH class of models. This flexible specification allows different effects to dominate as the level of the interest rate varies. We also investigate implications for the pricing of discount bond options. Our findings indicate that the inclusion of a volatility effect in addition to a level effect in the model specification is particularly relevant for the pricing of shorter-term discount bond options.
JEL Classification: E43
Suggested Citation: Suggested Citation