FIN-02-054 |
NYU Stern School of Business |
Term Structure Dynamics in Theory and Reality
July 2002
Qiang Dai and Kenneth Singleton
ABSTRACT
This paper is a critical survey of models designed for pricing fixed income securities and
their associated term structures of market yields. Our primary focus is on the interplay
between the theoretical specification of dynamic term structure models and their empirical
fit to historical changes in the shapes of yield curves. We begin by overviewing the dynamic
term structure models that have been fit to treasury or swap yield curves and in which
the risk factors follow diffusions, jump-diffusion, or have "switching regimes." Then the
goodness-of-fits of these models are assessed relative to their abilities to: (i) match linear
projections of changes in yields onto the slope of the yield curve; (ii) match the persistence
of conditional volatilities, and the shapes of term structures of unconditional volatilities, of
yields; and (iii) to reliably price caps, swaptions, and other fixed-income derivatives. For the
case of defaultable securities we explore the relative fits to historical yield spreads.
Qiang Dai
Institution: Stern School of Business, New York University, 44th West 4th Street, NY 10012
Telephone: (212) 998-0358
Fax: (212) 995-4233
Email: qdai@stern.nyu.edu
Homepage: http://www.stern.nyu.edu/~qdai
Kenneth Singleton
Institution: Graduate School of Business, Stanford University, Stan-
ford, CA 94305
Email:ken@future.stanford.edu
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