Term Structure Dynamics in Theory and Reality

46 Pages Posted: 7 Nov 2008

See all articles by Qiang Dai

Qiang Dai

University of North Carolina (UNC) at Chapel Hill - Finance Area

Kenneth J. Singleton

Stanford University - Graduate School of Business

Date Written: July 2002

Abstract

This paper is a critical survey of models designed for pricing fixed income securities and their associated term structures of market yields. Our primary focus is on the interplay between the theoretical specification of dynamic term structure models and their empirical fit to historical changes in the shapes of yield curves. We begin by overviewing the dynamic term structure models that have been fit to treasury or swap yield curves and in whichthe risk factors follow diffusions, jump-diffusion, or have \switching regimes." Then the goodness-of- ts of these models are assessed relative to their abilities to: (i) match linear projections of changes in yields onto the slope of the yield curve; (ii) match the persistence of conditional volatilities, and the shapes of term structures of unconditional volatilities, of yields; and (iii) to reliably price caps, swaptions, and other fixed-income derivatives. For thecase of defaultable securities we explore the relative fits to historical yield spreads.

Suggested Citation

Dai, Qiang and Singleton, Kenneth J., Term Structure Dynamics in Theory and Reality (July 2002). NYU Working Paper No. S-DRP-02-06, Available at SSRN: https://ssrn.com/abstract=1296425

Qiang Dai (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-7182 (Phone)

Kenneth J. Singleton

Stanford University - Graduate School of Business ( email )

Knight Management Center
655 Knight Way
Stanford, CA 94305-7298
United States
650-723-5753 (Phone)

HOME PAGE: http://www.stanford.edu/~kenneths

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