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Testing Continuous-Time Models of the Spot Interest Rate (1996)
| Venue: | Review of Financial Studies |
| Citations: | 309 - 9 self |
BibTeX
@ARTICLE{Aït-sahalia96testingcontinuous-time,
author = {Yacine Aït-sahalia and Lars Hansen and Mahesh Maheswaran and José Scheinkman and Rob Vishny},
title = {Testing Continuous-Time Models of the Spot Interest Rate},
journal = {Review of Financial Studies},
year = {1996},
volume = {9},
pages = {385--426}
}
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Abstract
Different continuous-time models for interest rates coexist in the literature. We test parametric models by comparing their implied parametric density to the same density estimated nonparametrically. We do not replace the continuous-time model by discrete approximations, even though the data are recorded at discrete intervals. The principal source of rejection of existing models is the strong nonlinearity of the drift. Around its mean, where the drift is essentially zero, the spot rate behaves like a random walk. The drift then mean-reverts strongly when far away from the mean. The volatility is higher when away from the mean. The continuous-time financial theory has developed extensive tools to price derivative securities when the underlying traded asset(s) or nontraded factor(s) follow stochastic differential equations [see Merton (1990) for examples]. However, as a practical matter, how to specify an appropriate stochastic differential equation is for the most part an unanswered question. For example, many different continuous-time The comments and suggestions of Kerry Back (the editor) and an anonymous referee were very helpful. I am also grateful to George Constantinides,
Keyphrases
continuous-time model spot interest rate george constantinides unanswered question strong nonlinearity anonymous referee appropriate stochastic differential equation parametric model principal source extensive tool continuous-time financial theory stochastic differential equation price derivative security traded asset kerry back interest rate random walk discrete approximation practical matter different continuous-time model discrete interval spot rate behaves implied parametric density
