A Parametric Nonlinear Model of Term Structure Dynamics

Ahn, Dong-Hyun; Gao, Bin

doi:10.1093/rfs/12.4.721

Cited by 298 publications

(229 citation statements)

References 34 publications

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“…We explored in-depth the relative goodness of fits of these two models, as well as a model in which λ Q follows a "three-halves" diffusion (see Ahn and Gao (1999) for a discussion of this model in a term structure setting), and concluded that, for the sovereign CDS spreads and sample period examined, the lognormal model fit the best.…”

Section: On the Sensitivity Of Results To Modeling Choicesmentioning

confidence: 99%

Default and Recovery Implicit in the Term Structure of Sovereign CDS Spreads

2005

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This paper explores the nature of default arrival and recovery implicit in the term structures of sovereign CDS spreads. We argue that term structures of spreads reveal not only the arrival rates of credit events (λ Q ), but also the loss rates given credit events. Applying our framework to Mexico, Turkey, and Korea, we show that a single-factor model with λ Q following a lognormal process captures most of the variation in the term structures of spreads. The risk premiums associated with unpredictable variation in λ Q are found to be economically significant and co-vary importantly with several economic measures of global event risk, financial market volatility, and macroeconomic policy.THE BURGEONING MARKET FOR SOVEREIGN CREDIT DEFAULT SWAPS (CDS) contracts offers a nearly unique window for viewing investors' risk-neutral probabilities of major credit events impinging on sovereign issuers, and their risk-neutral losses of principal in the event of a restructuring or repudiation of external debts. In contrast to many "emerging market" sovereign bonds, sovereign CDS contracts are designed without complex guarantees or embedded options. Trading activity in the CDS contracts of several sovereign issuers has developed to the point that they are more liquid than many of the underlying bonds. Moreover, in contrast to the corporate CDS market, where trading has been concentrated largely in the 5-year maturity contract, CDS contracts at several maturity points between 1 and 10 years have been actively traded for several years. As such, a full term structure of CDS spreads is available for inferring default and recovery information from market data. This paper explores in depth the time-series properties of the risk-neutral mean arrival rates of credit events (λ Q ) implicit in the term structure of sovereign CDS spreads. Applying our framework to Mexico, Turkey, and Korea, three countries with different geopolitical characteristics and credit ratings, we * Pan is with the MIT Sloan School of Management and NBER. Singleton is with the Graduate 2346The Journal of Finance find that single-factor models, in which country-specific λ Q follow lognormal processes, 1 capture most of the variation in the term structures of spreads. The maximum likelihood estimates suggest that, for all three countries, there are systematic, priced risks associated with unpredictable future variation in λ Q . Moreover, the time-series of the effects of risk premiums on CDS spreads covary strongly across countries. There are several large concurrent "run-ups" in risk premiums during our sample period (March 2001 through August 2006 that have natural interpretations in terms of political, macroeconomic, and financial market developments at the time.A more formal regression analysis of the correlations between risk premiums and the CBOE U.S. VIX option volatility index (viewed as a measure of event risk), the spread between the 10-year return on U.S. BB-rated industrial corporate bonds and the 6-month U.S. Treasury bill rate (viewed as a me...

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Section: On the Sensitivity Of Results To Modeling Choicesmentioning

confidence: 99%

Default and Recovery Implicit in the Term Structure of Sovereign CDS Spreads

2005

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“…, T } where the final time T = 1/6. The conditional mean of the iCIR process is quite lengthy and involves a Gamma function and will not be expressed here, see Ahn and Gao (1999). The absolute error between the proposed method, conditional moments using the Itō -Taylor expansion and the Euler-Maruyama scheme are compared to the exact moments for the CIR model in Figure 1.…”

Section: Convergencementioning

confidence: 99%

Efficient computation of the quasi likelihood function for discretely observed diffusion processes

Höök

Lindström

2016

Computational Statistics & Data Analysis

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We introduce a simple method for nearly simultaneous computation of all moments needed for quasi maximum likelihood estimation of parameters in discretely observed stochastic differential equations commonly seen in finance. The method proposed in this papers is not restricted to any particular dynamics of the differential equation and is virtually insensitive to the sampling interval. The key contribution of the paper is that computational complexity is sublinear in the number of observations as we compute all moments through a single operation. Furthermore, that operation can be done offline. The simulations show that the method is unbiased for all practical purposes for any sampling design, including random sampling, and that the computational cost is comparable (actually faster for moderate and large data sets) to the simple, often severely biased, EulerMaruyama approximation.

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“…Inverse square root process. Ahn and Gao (1998) suggested that the interest rate process could be defined as the reciprocal of a square root process. An application of the Itô's Lemma provides the SDE of the resulting specification:…”

Section: Setupmentioning

confidence: 99%

Efficient importance sampling maximum likelihood estimation of stochastic differential equations

Pastorello

Rossi

2010

Computational Statistics & Data Analysis

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This paper considers ML estimation of a diffusion process observed discretely. Since the exact loglikelihood is generally not available, it must be approximated. We review the most efficient approaches in the literature, and point to some drawbacks. We propose to approximate the loglikelihood using the EIS strategy (Richard and Zhang, 1998), and detail its implementation for univariate homogeneous processes. Some Monte Carlo experiments evaluate its performance against an alternative IS strategy (Durham and Gallant, 2002), showing that EIS is at least equivalent, if not superior, while allowing a greater flexibility needed when examining more complicated models.JEL codes: C13, C15, C22

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A Parametric Nonlinear Model of Term Structure Dynamics

Cited by 298 publications

References 34 publications

Default and Recovery Implicit in the Term Structure of Sovereign CDS Spreads

Default and Recovery Implicit in the Term Structure of Sovereign CDS Spreads

Efficient computation of the quasi likelihood function for discretely observed diffusion processes

Efficient importance sampling maximum likelihood estimation of stochastic differential equations

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