What Does a Term Structure Model Imply about Very Long-Term Interest Rates?

30 Pages Posted: 14 Feb 2015 Last revised: 25 Sep 2016

See all articles by Anne Balter

Anne Balter

Tilburg University; Netspar

Antoon Pelsser

Maastricht University; Netspar

Peter C. Schotman

Maastricht University - Department of Finance

Date Written: September 24, 2016

Abstract

We extrapolate interest rate yield curves for the purpose of discounting very long-dated pension liabilities and insurance contracts. The extrapolation uses a no-arbitrage term structure model estimated on liquid euro swap instruments with maturities between 5 and 20 years. The extrapolation towards maturities up to 100 years appears mainly driven by the near unit root of the level factor under the risk neutral measure. In a no-arbitrage term structure model this leads to a strong convexity effect at the very long end of the yields curve and a very low ultimate forward rate (UFR). Our estimates use Bayesian methods with an informative prior on mean reversion parameters and the unconditional means. As a puzzle for term structure models we find that our extrapolated curves are generally above observed swap rates at maturities in the 20-50 years range.

Keywords: term structure models, parameter uncertainty, extrapolation, insurance supervision

JEL Classification: G23, G12, C58

Suggested Citation

Balter, Anne and Pelsser, Antoon A. J. and Schotman, Peter C., What Does a Term Structure Model Imply about Very Long-Term Interest Rates? (September 24, 2016). Netspar Discussion Paper No. 02/2014-065, Available at SSRN: https://ssrn.com/abstract=2564487 or http://dx.doi.org/10.2139/ssrn.2564487

Anne Balter

Tilburg University ( email )

P.O. Box 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Antoon A. J. Pelsser

Maastricht University ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands

HOME PAGE: http://https://sites.google.com/site/apelsseraca/

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Peter C. Schotman (Contact Author)

Maastricht University - Department of Finance ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands
+31 43 388 3862 (Phone)
+31 43 388 4875 (Fax)

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