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Improving the term structure of interest rates: two‐factor models
Author(s) -
GómezValle Lourdes,
MartínezRodríguez Julia
Publication year - 2010
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.392
Subject(s) - yield curve , economics , econometrics , term (time) , treasury , volatility (finance) , affine term structure model , interest rate , mathematics , physics , monetary economics , archaeology , quantum mechanics , history
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.