DP2034 | Direct Estimation of the Risk Neutral Factor Dynamics of Affine Term Structure Models

Publication Date

18/12/1998

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Abstract

This paper proposes a panel data framework for tests of affine models of the term structure of interest rates which cover equilibrium (or endogenous) models as well as extended (or exogenous, evolutionary) models. The econometric model pools yield curve data for different moments in time. Since each cross-sectional yield curve only depends on the risk neutral factor dynamics, the estimator does not involve any assumptions on the price of risk, or on actual interest rate dynamics. In the empirical application one and two factor Gaussian models are tested on US interest rate data. The main empirical results are: (i) that a two-factor model cannot be rejected; (ii) that mean reversion is highly significant; and (iii) that the extended models are 'over-differenced'.