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Risk premia and volatilities in a nonlinear term structure model

Journal

Review of Finance

Subject

Finance

Authors / Editors

Feldhutter P;Heyerdahl-Larsen C;Illeditsch P

Publication Year

2018

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 U.S. 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).

Keywords

Nonlinear Term Structure Models; Expected Excess Returns; Stochastic Volatility; Unspanned Risk Premia (URP); Unspanned Stochastic Volatility (USV).

Available on ECCH

No


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