Gaussian Estimation of Single-Factor Continuous Time Models of The Term Structure of Interest Rates

Authors

  • K. B. NOWMAN

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    • First National Bank of Chicago, London, United Kingdom. I thank Rex Bergstrom for suggesting the approach of assuming that the volatility of the short-term interest rate is constant over the unit observation period and using his Gaussian estimation methods. I thank the editor, René Stulz and an anonymous referee for valuable comments and suggestions. Thanks to Jesper Lund, Simon Babbs, Sanjay Yadav, Andrew Johnson, and Graham Hunt for comments, I thank Linda Stone and The Center for Research in Security Prices (CRSP), Graduate School of Business, University of Chicago for permission to use the U.S. T-bill data used in CKLS, and Andrew Karolyi for sending me the data. I thank Angelo Melino and Jesper Lund for sending me research papers. The views expressed are those of the author and not necessarily those of First National Bank of Chicago.


ABSTRACT

This article presents the first application in finance of recently developed methods for the Gaussian estimation of continuous time dynamic models. A range of one factor continuous time models of the short-term interest rate are estimated using a discrete time model and compared to a recent discrete approximation used by Chan, Karolyi, Longstaff, and Sanders (1992a, hereafter CKLS). Whereas the volatility of short-term rates is highly sensitive to the level of rates in the United States, it is not in the United Kingdom.

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