Specification Analysis of Affine Term Structure Models

Authors

  • Qiang Dai,

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    • Dai is from New York University. Singleton is from Stanford University. We thank Darrell Duffie for extensive discussions, Ron Gallant and Jun Liu for helpful comments, the editor and the referees for valuable inputs, and the Financial Research Initiative of the Graduate School of Business at Stanford University for financial support. We are also grateful for comments from seminar participants at the NBER Asset Pricing Group meeting, the Western Finance Association Annual Meetings, Duke University, London Business School, New York University, Northwestern University, University of Chicago, University of Michigan, University of Washington at St. Louis, Columbia University, Carnegie Mellon University, and CIRANO.
  • Kenneth J. Singleton

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    • Dai is from New York University. Singleton is from Stanford University. We thank Darrell Duffie for extensive discussions, Ron Gallant and Jun Liu for helpful comments, the editor and the referees for valuable inputs, and the Financial Research Initiative of the Graduate School of Business at Stanford University for financial support. We are also grateful for comments from seminar participants at the NBER Asset Pricing Group meeting, the Western Finance Association Annual Meetings, Duke University, London Business School, New York University, Northwestern University, University of Chicago, University of Michigan, University of Washington at St. Louis, Columbia University, Carnegie Mellon University, and CIRANO.

Abstract

This paper explores the structural differences and relative goodness-of-fits of affine term structure models (ATSMs). Within the family of ATSMs there is a trade-off between flexibility in modeling the conditional correlations and volatilities of the risk factors. This trade-off is formalized by our classification of N-factor affine family into N+1 non-nested subfamilies of models. Specializing to three-factor ATSMs, our analysis suggests, based on theoretical considerations and empirical evidence, that some subfamilies of ATSMs are better suited than others to explaining historical interest rate behavior.

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