What Does a Term Structure Model Imply about Very Long-Term Interest Rates?
30 Pages Posted: 14 Feb 2015 Last revised: 25 Sep 2016
Date Written: September 24, 2016
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: Suggested Citation