Abstract: Affine term structure models in which the short rate follows a jumpdiffusion process are difficult to solve,
and the parameters of such models are hard to estimate. Without analytical answers to the partial difference
differential equation (PDDE) for bond prices implied by jumpdiffusion processes, one must find a numerical
solution to the PDDE or exactly solve an approximate PDDE. Although the literature focuses on a single
linearization technique to estimate the PDDE, this paper outlines alternative methods that seem to improve
accuracy. Also, closedform solutions, numerical estimates, and closedform approximations of the PDDE each
ultimately depend on the presumed distribution of jump sizes, and this paper explores a broader set of possible
densities that may be more consistent with intuition, including a bimodal Gaussian mixture. GMM and MLE of
one and twofactor jumpdiffusion models produce some evidence for jumps, but sensitivity analyses suggest
sizeable confidence intervals around the parameters.
Keywords: Jumpdiffusion, termstructure models
Full paper (265 KB PDF)
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Last update: December 3, 2005
