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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/26367
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| Title: | Discrete-time Dynamic Term Structure Models with Generalized Market
Prices of Risk |
| Authors: | Dai, Qiang
Le, Anh
Singleton, Kenneth J. |
| Issue Date: | 7-Mar-2006 |
| Series/Report no.: | FIN-06-007 |
| Abstract: | This paper develops a rich class of discrete-time, nonlinear dynamic
term structure models (DTSMs). Under the risk-neutral measure, the
distribution of the state vector Xt resides within a family of
discrete-time affine processes that nests the exact discrete-time
counter parts of the entire class of continuous-time models in Duffie
and Kan (1996) and Dai and Singleton (2000). Moreover, we allow the
market price of risk ¤t, linking the risk-neutral and historical
distributions of X, to depend generally on the state Xt. The conditional
likelihood functions for coupon bond yields for the resulting nonlinear
models under the historical measure are known exactly in closed form. As
an illustration of our approach, we estimate a three factor model with a
cubic term in the drift of the stochastic volatility factor and compare
it to a model with a linear drift. Our results show that inclusion of a
cubic term in the drift significantly improves the models statistical
fit as well as its out-of-sample forecasting performance. |
| URI: | http://hdl.handle.net/2451/26367 |
| Appears in Collections: | Finance Working Papers
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