Article1992

An Empirical Comparison of Alternative Models of the Short-Term Interest Rate

K.C. Chan · George Andrew Karolyi · Francis A. Longstaff · Anthony Bown Sanders

1,679 citations0/0 files storedThe Journal of Finance

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Stochastic processes and financial applications Monetary Policy and Economic Impact Financial Markets and Investment Strategies

Abstract

ABSTRACT We estimate and compare a variety of continuous‐time models of the short‐term riskless rate using the Generalized Method of Moments. We find that the most successful models in capturing the dynamics of the short‐term interest rate are those that allow the volatility of interest rate changes to be highly sensitive to the level of the riskless rate. A number of well‐known models perform poorly in the comparisons because of their implicit restrictions on term structure volatility. We show that these results have important implications for the use of different term structure models in valuing interest rate contingent claims and in hedging interest rate risk.

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References

1973The Pricing of Options and Corporate Liabilities 1979Distribution of the Estimators for Autoregressive Time Series with a Unit Root 1981Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root 1979Distribution of the Estimators for Autoregressive Time Series With a Unit Root 1985A Theory of the Term Structure of Interest Rates 1973Theory of Rational Option Pricing 2005Theory of rational option pricing 1977An equilibrium characterization of the term structure

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