Modelling the Term Structure of Interest Rates: A Literature Review

Canto, Rosa

doi:10.2139/ssrn.1640424

“…They are used to price contingent claims, manage financial risk and assess the cost of capital. In most models the short-rate plays a very important role (Lhabitant et al 2001, Musiela & Rutkowski 2005, Canto 2008). The time-series dynamics of the short-rate are important and difficult to model over long periods due to changes in monetary regimes and economic shocks.…”

Section: Introductionmentioning

confidence: 99%

An infinite hidden Markov model for short-term interest rates

Maheu

¹

,

Yang

²

2016

Journal of Empirical Finance

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The time-series dynamics of short-term interest rates are important as they are a key input into pricing models of the term structure of interest rates. In this paper we extend popular discrete time short-rate models to include Markov switching of infinite dimension. This is a Bayesian nonparametric model that allows for changes in the unknown conditional distribution over time. Applied to weekly U.S. data we find significant parameter change over time and strong evidence of non-Gaussian conditional distributions. Our new model with an hierarchical prior provides significant improvements in density forecasts as well as point forecasts. We find evidence of recurring regimes as well as structural breaks in the empirical application.key words: hierarchical Dirichlet process prior, beam sampling, Markov switching, MCMC JEL: C58, C14, C22, C11 * We are grateful for helpful comments from Yong Song and seminar participants at the University of Toronto. Maheu thanks the SSHRC for financial support.

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“…They are used to price contingent claims, manage financial risk and assess the cost of capital. In most models the short-rate plays a very important role (Lhabitant et al 2001, Musiela & Rutkowski 2005, Canto 2008. The time-series dynamics of the short-rate are important and difficult to model over long periods due to changes in monetary regimes and economic shocks.…”

Section: Introductionmentioning

confidence: 99%

An Infinite Hidden Markov Model for Short-term Interest Rates

Maheu

¹

,

Yang

²

2016

SSRN Journal

1

0

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The time-series dynamics of short-term interest rates are important as they are a key input into pricing models of the term structure of interest rates. In this paper we extend popular discrete time short-rate models to include Markov switching of infinite dimension. This is a Bayesian nonparametric model that allows for changes in the unknown conditional distribution over time. Applied to weekly U.S. data we find significant parameter change over time and strong evidence of non-Gaussian conditional distributions. Our new model with an hierarchical prior provides significant improvements in density forecasts as well as point forecasts. We find evidence of recurring regimes as well as structural breaks in the empirical application.

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Interest rate uncertainty and investment value: a second order moment approach

Carmichael

¹

,

Bustamante

²

2014

IJEME

6

0

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Fluctuations in the fundamental investment variable of interest rate over the life of an investment introduce uncertainty. The paper explores the relationship between interest rate uncertainty and investment value. In particular it looks at, and provides support for, the proposition that uncertainty in interest rates increases the value of an investment. The paper's contribution is that it does this in a readily understandable way, and demonstrates a clear relationship of value increase to underlying parameters, in contradistinction with existing treatments. A case study of a long-term infrastructure project is given in support of the theory.

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Modelling the Term Structure of Interest Rates: A Literature Review

Cited by 3 publications

References 44 publications

An infinite hidden Markov model for short-term interest rates

An infinite hidden Markov model for short-term interest rates

An Infinite Hidden Markov Model for Short-term Interest Rates

Interest rate uncertainty and investment value: a second order moment approach

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