Abstract: This paper implements a Multivariate Weighted Nonlinear Least Square
estimator
for a class of jumpdiffusion interest rate processes (hereafter MWNLSJD),
which also admit closedform solutions to bond prices under a
noarbitrage argument. The instantaneous interest rate is modeled as a
mixture of a squareroot diffusion process and a Poisson jump
process. One can derive analytically
the first four conditional moments, which form the basis of the
MWNLSJD estimator. A diagnostic conditional moment test can also be
constructed from the
fitted moment conditions. The market prices of diffusion and jump risks are
calibrated by minimizing the pricing errors between a modelimplied yield
curve and a target yield curve. The time series estimation of the
shortterm
interest rate
suggests that the jump augmentation is highly significant and that the pure
diffusion process is strongly rejected. The crosssectional evidence
indicates
that the jumpdiffusion yield curves are both more flexible in reducing
pricing errors and are more consistent with the Martingale pricing
principle.
Keywords: Jumpdiffusion, term structure of interest rates, conditional moment generator, multivariate weighted nonlinear least square, market price of risk.
Full paper (1301 KB PDF)
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Last update: July 24, 2001
