Linear-Quadratic Term Structure Models – Toward the Understanding of Jumps in Interest Rates

13 Pages Posted: 20 Mar 2006 Last revised: 3 Oct 2012

See all articles by George J. Jiang

George J. Jiang

Washington State University

Shu Yan

Oklahoma State University - Stillwater - Department of Finance

Date Written: January 1, 2009

Abstract

In this paper, we propose a unifying class of affine-quadratic term structure models (AQTSMs) in the general jump-diffusion framework. Extending existing term structure models, the AQTSMs incorporate random jumps of stochastic intensity in the short rate process. Using information from the Treasury futures market, we propose a GMM approach for the estimation of the risk-neutral process. A distinguishing feature of the approach is that the time series estimates of stochastic volatility and jump intensity are obtained, together with model parameter estimates. Our empirical results suggest that stochastic jump intensity significantly improves the model fit to the term structure dynamics. We identify a stochastic jump intensity process that is negatively correlated with interest rate changes. Overall, negative jumps tend to have a larger size than positive ones. Our empirical results also suggest that, at monthly frequency, while stochastic volatility has certain predictive power of inflation, jumps are neither triggered by nor predictive of changes in macroeconomic variables. At daily frequency, however, we document interesting patterns for jumps associated with informational shocks in the financial market.

Keywords: Term Structure, Affine, Quadratic, Jumps, GMM

JEL Classification: G12, G13, C32

Suggested Citation

Jiang, George and Yan, Shu, Linear-Quadratic Term Structure Models – Toward the Understanding of Jumps in Interest Rates (January 1, 2009). Journal of Banking and Finance, 2009, Vol. 33, No. 3, Available at SSRN: https://ssrn.com/abstract=890140 or http://dx.doi.org/10.2139/ssrn.890140

George Jiang

Washington State University ( email )

Department of Finance and Management Science
Carson College of Business
Pullman, WA 99-4746164
United States
509-3354474 (Phone)

HOME PAGE: http://directory.business.wsu.edu/bio.html?username=george.jiang

Shu Yan (Contact Author)

Oklahoma State University - Stillwater - Department of Finance ( email )

Spears School of Business
Stillwater, OK 74078-4011
United States

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