A New Perspective on Gaussian Dynamic Term Structure Models

Review of Financial Studies, Forthcoming

AFA 2010 Atlanta Meetings Paper

55 Pages Posted: 23 Mar 2009 Last revised: 13 Oct 2010

See all articles by Scott Joslin

Scott Joslin

University of Southern California - Department of Finance and Business Economics

Kenneth J. Singleton

Stanford University - Graduate School of Business

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: October 12, 2010

Abstract

In any canonical Gaussian dynamic term structure model (GDTSM), the conditional forecasts of the pricing factors are invariant to the imposition of no-arbitrage restrictions. This invariance is maintained even in the presence of a variety of restrictions on the factor structure of bond yields. To establish these results, we develop a novel canonical GDTSM in which the pricing factors are observable portfolios of yields. For our normalization, standard maximum likelihood algorithms converge to the global optimum almost instantaneously. We present empirical estimates and out-of-sample forecasts for several GDTSMs using data on U.S. Treasury bond yields. Taken together, our results shed new light on estimation and interpretation of GDTSMs, as well as the eff ects of di fferent specifi cations of the risk premiums and the risk-neutral distribution of bond yields on the observed dynamics of the yield curve.

Keywords: dynamic term structure model, no-arbitrage, Gaussian, estimation

JEL Classification: E43, G12, C13

Suggested Citation

Joslin, Scott and Singleton, Kenneth J. and Zhu, Haoxiang, A New Perspective on Gaussian Dynamic Term Structure Models (October 12, 2010). Review of Financial Studies, Forthcoming, AFA 2010 Atlanta Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1364889 or http://dx.doi.org/10.2139/ssrn.1364889

Scott Joslin (Contact Author)

University of Southern California - Department of Finance and Business Economics ( email )

CA
United States

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

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street E62-623
Cambridge, MA 02142
United States

HOME PAGE: http://www.mit.edu/~zhuh

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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