Risk Premia and Volatilities in a Nonlinear Term Structure Model. (28th October 2016)

• Record Type: Journal Article
• Authors: Feldhütter, Peter; Heyerdahl-Larsen, Christian; Illeditsch, Philipp
• Is Part Of: Review of finance. Volume 22:Number 1(2018)
• Page Start: 337
• Page End: 380
• Publication Date: 2016-10-28
• Subjects: Nonlinear term structure models -- Expected excess returns -- Stochastic volatility -- Unspanned Risk Premia -- Unspanned Stochastic Volatility; Finance -- Europe -- Periodicals; Financiën; Finance; Periodicals; 332.09405
• DOI: 10.1093/rof/rfw052
• Languages: English
• ISSNs: 1572-3097

Abstract

Abstract: We introduce a reduced-form term structure model with closed-form solutions for yields where the short rate and market prices of risk are nonlinear functions of Gaussian state variables. The nonlinear model with three factors matches the time-variation in expected excess returns and yield volatilities of US Treasury bonds from 1961 to 2014. Yields and their variances depend on only three factors, yet the model exhibits features consistent with Unspanned Risk Premia (URP) and Unspanned Stochastic Volatility (USV).