Improving the term structure of interest rates: two‐factor models

Abstract

We consider a new approach for estimating the coefficients of the term structure equation in two-factor models. This approach is based on the fact that the risk-neutral drifts of the factors are directly estimated. Therefore, the market prices of risk and the physical drifts do not have to be either identified or estimated. In order to study the finite properties of this approach, we generate trajectories in a stochastic volatility model. We find that the risk-neutral drifts and the yield curves are more accurately estimated. Finally, we show the supremacy of this approach by means of US Treasury Bill data. Copyright © 2009 John Wiley & Sons, Ltd.

Perturbation analysis of a nonlinear equation arising in the Schaefer-Schwartz model of interest rates

“…Note that the result (21) is in accordance with comparing (10) with (5) from which it follows that ŝ = μ if s 0 = μ (i.e., ε = 0) as it is also noted in the paper [15].…”

“…A generalization of the original paper [15], considering a more general form of volatilities and correlations, has been studied using econometric time series techniques in [4]. Model with these variables is one of the two-factor models considered in [10], to which they applied their estimation methodology. We consider pricing bonds in this model and apply perturbation analysis (cf.…”