The Elasticity of Interest Rate Volatility: Chan, Karolyi, Longstaff, and Sanders Revisited

Federal Reserve Bank of Atlanta WP 97-13a

25 Pages Posted: 2 Sep 1998

See all articles by Robert R. Bliss

Robert R. Bliss

Wake Forest University - Schools of Business

David C. Smith

University of Virginia - McIntire School of Commerce

Date Written: March 1998

Abstract

This paper presents a careful reexamination of Chan, Karolyi, Longstaff, and Sanders (CKLS 1992). By redefining the possible regime shift period in line with evidence from known policy changes and past empirical research, we find evidence that contradicts the major results in their paper. The widely cited conclusion of their paper is that the elasticity of interest rate volatility is 1.5. CKLS also concluded that there was no structural shift in the interest rate process after October 1979. When the structural shift period is defined to be temporary and coincident with the Federal Reserve Experiment of October 1979 through September 1982, we find that there is strong evidence of a structural break. Furthermore, we find evidence that, contrary to CKLS's claim, a moderately elastic interest rate process can capture the dependence of volatility on the level of interest rates, while highly elastic models cannot. In particular, this study finds support for the square-root CIR process. These results are robust to changes in the short- rate data used and the treatment of outliers.

JEL Classification: E40, C52

Suggested Citation

Bliss, Robert R. and Smith, David Carl, The Elasticity of Interest Rate Volatility: Chan, Karolyi, Longstaff, and Sanders Revisited (March 1998). Federal Reserve Bank of Atlanta WP 97-13a. Available at SSRN: https://ssrn.com/abstract=99894 or http://dx.doi.org/10.2139/ssrn.99894

Robert R. Bliss (Contact Author)

Wake Forest University - Schools of Business ( email )

P.O. Box 7659
Winston-Salem, NC 27109-7285
United States

David Carl Smith

University of Virginia - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States

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