Hostname: page-component-cd9895bd7-fscjk Total loading time: 0 Render date: 2024-12-26T07:24:17.034Z Has data issue: false hasContentIssue false
  • English
  • Français

An International Examination of Affine Term Structure Models and the Expectations Hypothesis

Published online by Cambridge University Press:  06 April 2009

Huarong Tang  and
Yihong Xia
Huarong Tang
Affiliation:
[email protected], Fixed Income Research, Lehman Brothers International, 25 Bank Street, London, E14 5LE, U.K.
Yihong Xia
Affiliation:
The Finance Department, the Wharton School, University of Pennsylvania, passed away in August 2005.
Get access Rights & Permissions [Opens in a new window]

Abstract

We examine the yield curve behavior and the relative performance of affine term structure models (ATSMs) using government bond yield data from Canada, Germany, Japan, the U.K., and the U.S. We find strong predictability of forward rates for excess bond returns and reject the expectations hypothesis in all five countries. A three-factor model is sufficient to capture movements in the yield curve of Canada, Japan, the U.K., and the U.S., but may not be enough for Germany. An exhaustive comparison among ATSMs with no more than three factors reveals that the three-factor essential affine model (A1(3)E), with only one factor affecting the volatility of the short rate but with all three factors affecting the price of risk, performs best in all five countries. Simulations provide inconclusive evidence on whether this best affine model can successfully generate the rich yield curve behavior observed in the data.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 42 , Issue 1 , March 2007 , pp. 41 - 80
Copyright
Copyright © School of Business Administration, University of Washington 2007

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

D.-H., Ahn; Dittmar, R. F.; and Gallant, A. R.. “Quadratic Term Structure Models: Theory and Evidence.” Review of Financial Studies, 15 (2002), 243–288.Google Scholar
Amihud, Y., and Hurvich, C. M.. “Predictive Regressions: A Reduced-Bias Estimation Method.” Journal of Financial and Quantitative Analysis, 39 (2004), 813–841.CrossRefGoogle Scholar
Andrews, D. W. K., and Ploberger, W.. “Optimal Tests When a Nuisance Parameter is Present Only under the Alternative.” Econometrica, 62 (1994), 1383–1414.CrossRefGoogle Scholar
Bansal, R.; Tauchen, G.; and Zhou, H.. “Regime-Shifts, Risk Premiums in the Term Structure, and the Business Cycle.” Working Paper, Duke University (2003).Google Scholar
Bansal, R., and Zhou, H.. “Term Structure of Interest Rates with Regime Shifts.” Journal of Finance, 57 (2002), 1997–2043.CrossRefGoogle Scholar
Bekaert, G., and Harvey, C.. “Time-Varying World Market Integration.” Journal of Finance, 50 (1995), 403–444.Google Scholar
Bekaert, G.; Hodrick, R. J.; and Marshall, D. A.. “On Biases in Tests of the Expectations Hypothesis of the Term Structure of Interest Rates.” Journal of Financial Economics, 44 (1997), 309–348.CrossRefGoogle Scholar
Bekaert, G.; Wei, M.; and Xing, Y.. “Uncovered Interest Rate Parity and the Term Structure.” Working Paper, Columbia University (2002).CrossRefGoogle Scholar
Boisvert, S., and Harvey, N.. “The Declining Supply of Treasury Bills and the Canadian Money Market.” Bank of Canada Review (1998), 53–69.Google Scholar
Boudoukh, J., and Whitelaw, R. F.. “The Benchmark Effect in the Japanese Government Bond Market.” Journal of Fixed Income, 1 (1991), 52–59.CrossRefGoogle Scholar
Brandt, M. W., and Chapman, D. A.. “Comparing Multifactor Models of the Term Structure.” Working Paper, Duke University (2002).Google Scholar
Brennan, M. J., and Xia, Y.. “International Capital Markets and Foreign Exchange Risk.” Review of Financial Studies, 19 (2006), 753–795.CrossRefGoogle Scholar
Buraschi, A., and Menini, D.. “Liquidity Risk and Specialness.” Journal of Financial Economics, 64 (2002), 243–284.CrossRefGoogle Scholar
Campbell, J. Y., and Shiller, R. J.. “Yield Spreads and Interest Rate Movements: A Bird's Eye View.” Review of Economics Studies, 58 (1991), 495–514.CrossRefGoogle Scholar
Cochrane, J. H., and Piazzesi, M.. “Bond Risk Premia.” Working Paper, UCLA (2002).CrossRefGoogle Scholar
Dai, Q., and Singleton, K. J.. “Specification Analysis of Affine Term Structure Models.” Journal of Finance, 55 (2000), 1943–1978.CrossRefGoogle Scholar
Dai, Q., and Singleton, K. J.. “Expectation Puzzles, Time-Varying Risk Premia, and Dynamic Models of the Term Structure.” Journal of Financial Economics, 63 (2002), 415–441.CrossRefGoogle Scholar
Dai, Q., and Singleton, K. J.. “Term Structure Dynamics in Theory and Reality.” Review of Financial Studies, 16 (2003), 631–678.CrossRefGoogle Scholar
de Jong, F. “Time-Series and Cross-Section Information in Affine Term Structure Models.” Journal of Business and Economics Statistics, 18 (2000), 300–314.CrossRefGoogle Scholar
Duarte, J. “Evaluating an Alternative Risk Preference in Affine Term Structure Models.” Review of Financial Studies, 17 (2004), 379–404.CrossRefGoogle Scholar
Duffee, G. R. “Term Premia and Interest Rate Forecasts in Affine Models.” Journal of Finance, 57 (2002), 405–443.CrossRefGoogle Scholar
Duffee, G. R., and Stanton, R. H.. “Estimation of Dynamic Term Structure Models.” Working Paper, UC Berkeley (2002).Google Scholar
Duffie, D. “Special Repo Rates.” Journal of Finance, 51 (1996), 493–526.CrossRefGoogle Scholar
Duffie, D., and Kan, R.. “A Yield-Factor Model of Interest Rates.” Mathematical Finance, 6 (1996), 379–406.CrossRefGoogle Scholar
Fama, E. F. “The Information in the Term Structure of Interest Rates.” Journal of Financial Economics, 13 (1984), 509–528.CrossRefGoogle Scholar
Fama, E. F., and Bliss, R. T.. “The Information in Long-Maturity Forward Rates.” American Economic Review, 77 (1987), 680–692.Google Scholar
Hardouvelis, G. A. “The Term Structure Spread and Future Changes in Long and Short Rates in the G7 Countries: Is There a Puzzle?” Journal of Monetary Economics, 33 (1994), 255–284.CrossRefGoogle Scholar
Hansen, B. E. “Inference When a Nuisance Parameter is Not Identified under the Null Hypothesis.” Econometrica, 64 (1996), 413–430.CrossRefGoogle Scholar
Jordan, B. D., and Jordan, S. D.. “Special Repo Rates: An Empirical Analysis.” Journal of Finance, 52 (1997), 2051–2072.CrossRefGoogle Scholar
Jorion, P., and Mishkin, F.. “A Multicountry Comparison of Term-Structure Forecasts at Long Horizons.” Journal of Financial Economics, 29 (1991), 59–80.CrossRefGoogle Scholar
Litterman, R., and Scheinkman, J.. “Common Factors Affecting Bond Returns.” Journal of Fixed Income, 1 (1991), 54–61.CrossRefGoogle Scholar
McCulloch, J. H., and Kwon, H.. “U.S. Term Structure Data: 1947–1991.” Working Paper, Ohio State University (1993).Google Scholar
Stambaugh, R. F. “The Information in the Forward Rates: Implications for Models of the Term Structure.” Journal of Financial Economics, 21 (1988), 41–69.CrossRefGoogle Scholar