The Stochastic Volatility of Short‐Term Interest Rates: Some International Evidence

Abstract

This paper estimates a stochastic volatility model of short-term riskless interest rate dynamics. Estimated interest rate dynamics are broadly similar across a number of countries and reliable evidence of stochastic volatility is found throughout. In contrast to stock returns, interest rate volatility exhibits faster meanreverting behavior and innovations in interest rate volatility are negligibly correlated with innovations in interest rates. The less persistent behavior of interest rate volatility ref lects the fact that interest rate dynamics are impacted by transient economic shocks such as central bank announcements and other macroeconomic news.THE PAST DECADE HAS WITNESSED UNPRECEDENTED GROWTH in the market for fixedincome derivatives, domestically as well as internationally. In light of this growth, recent research has attempted to empirically characterize the dynamics of short-term riskless interest rates necessary for the valuation of many of these securities. With few exceptions much of this evidence has been concerned with the behavior of U.S. interest rates. The purpose of this paper is to investigate the dynamics of short-term interest rates across a number of countries.A particularly noteworthy feature, at least of the U.S. evidence, is that the volatility of short-term interest rates is itself volatile. The stochastic nature of volatility is an important property of interest rate dynamics which we wish to focus on in our comparison. To do so practically, this paper implements a computationally efficient and statistically reliable method for estimating stochastic volatility models in finance. We apply this method to Chan et al.'s~1992! specification of short-term riskless interest rate dynamics augmented with stochastic volatility.For a clean international comparison, we use proxies for short-term riskless interest rates drawn from the same market, the London interbank market, over the same sample period.

Oil prices and the impact of the financial crisis of 2007–2009

“…Although, the use of Vuong's non-nested likelihood ratio test is a relatively recent development in financial economics, it has been successfully adopted by, Danielsson (1998), Ball and Torous (1999) and Smith (2002) to name a few. This test statistic has a well-defined limiting distribution; i.e.…”

Short rate nonlinearities and regime switches

“…5 We estimate the models for US data, and also estimate the models jointly over three countries (US, UK and Germany) using the cross-sectional approach of Bekaert, Hodrick and Marshall (2000). For the three-country cross-sectional estimation we assume the innovations and regimes are independent across countries.…”

Sources of time varying return comovements during different economic regimes: evidence from the emerging Indian equity market

“…Therefore, in contrast to the ARCH-type models, we allow the log volatility of the state variables to evolve stochastically over time. Following the discrete type convention (Ball and Torous 1999;Shephard 1996), we characterize the SV model as an extension of the time-diffusion process…”