Risk Premia and Volatilities in a Nonlinear Term Structure Model
Review of Finance, Forthcoming
74 Pages Posted: 1 Apr 2013 Last revised: 2 Sep 2020
Date Written: September 1, 2016
We introduce a reduced-form term structure model with closed-form solutions for yields where the short rate and market prices of risk are nonlinear functions of Gaussian state variables. The nonlinear model with three factors matches the time-variation in expected excess returns and yield volatilities of U.S. Treasury bonds from 1961 to 2014. Yields and their variances depend on only three factors, yet the model exhibits features consistent with unspanned risk premia (URP) and unspanned stochastic volatility (USV).
Keywords: Nonlinear Term Structure Models, Expected Excess Returns, Stochastic Volatility, Unspanned Risk Premia (URP), Unspanned Stochastic Volatility (USV)
JEL Classification: D51, E43, E52, G12
Suggested Citation: Suggested Citation