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The Dynamics of the Forward Interest Rate Curve: A Formulation with State Variables

Published online by Cambridge University Press:  06 April 2009

Frank de Jong  and
Pedro Santa-Clara
Frank de Jong
Affiliation:
Finance Group, University of Amsterdam, Roetersstraat 11, 1018 WB, Amsterdam, The Netherlands
Pedro Santa-Clara
Affiliation:
Anderson Graduate School of Management, UCLA, Westwood Plaza, Los Angeles, CA 90095-1481
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Abstract

The objective of this paper is twofold. First, the paper develops a class of models of the term structure of interest rates, in the Heath, Jarrow, and Morton (1992) framework, with dynamics characterized by the evolution of a small set of state variables. Second, the paper exploits this characterization of the dynamics of the term structure in an estimation exercise that makes use of both the time series and cross-section of bond prices. In this way, our class of models bridges the gap between traditional models, such as Cox, Ingersoll, and Ross (1985) and Vasicek (1977), that emphasize the dynamics of interest rates and the models of Heath, Jarrow, and Morton (1992) that stress fitting the cross-section of bond prices.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 34 , Issue 1 , March 1999 , pp. 131 - 157
Copyright
Copyright © School of Business Administration, University of Washington 1999

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