Skip navigation

Specification Analysis of Affine Term Structure Models

Authors: Dai, Qiang
Singleton, Kenneth J.
Issue Date: 27-Oct-1998
Series/Report no.: FIN-98-083
Abstract: In this paper, we explore the features of affine term structure models that are empirically important for explaining the joint distribution of yields on short and long-term interest rate swaps. We begin by showing that the family of N-factor affine models can be classified into N+1 non-nested sub-families of models. For each sub-family, we derive a maximal model with the property that every admissible member of this family is equivalent to or a nested special case of our maximal model. Second, using our classification scheme and maximal models, we show that many of the three-factor models in the literature impose potentially strong over-identifying restrictions on the joint distribution of short- and long-term rates. Third, we compute simulated method-of-moments estimates for several members of one of the four branches of three-factor models, and test the over-identifying restrictions implied by these models. We conclude that many of the extant affine models in the literature fail to describe important features of the distribution of long- and short- term rates. The source of the model misspecification is shown to be overly strong restrictions on the correlations among the state variables. Relaxing these restrictions leads to a model that passes several goodness-of-fit tests over our sample period.
Appears in Collections:Finance Working Papers

Files in This Item:
File Description SizeFormat 
wpa98083.pdf2.08 MBAdobe PDFView/Open

Items in FDA are protected by copyright, with all rights reserved, unless otherwise indicated.