Premium
An Empirical Comparison of Alternative Models of the Short‐Term Interest Rate
Author(s) -
CHAN K. C.,
KAROLYI G. ANDREW,
LONGSTAFF FRANCIS A.,
SANDERS ANTHONY B.
Publication year - 1992
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1992.tb04011.x
Subject(s) - interest rate , rendleman–bartter model , term (time) , econometrics , yield curve , short rate , volatility (finance) , short rate model , interest rate derivative , vasicek model , economics , macroeconomics , physics , quantum mechanics
We estimate and compare a variety of continuous‐time models of the short‐term riskless rate using the Generalized Method of Moments. We find that the most successful models in capturing the dynamics of the short‐term interest rate are those that allow the volatility of interest rate changes to be highly sensitive to the level of the riskless rate. A number of well‐known models perform poorly in the comparisons because of their implicit restrictions on term structure volatility. We show that these results have important implications for the use of different term structure models in valuing interest rate contingent claims and in hedging interest rate risk.