Date of this Version
Review of Finance
We introduce a reduced-form term structure model with closed-form solutions for yields where the short rate and market prices of risk are nonlinear functions of Gaussian state variables. The nonlinear model with three factors matches the time-variation in expected excess returns and yield volatilities of US Treasury bonds from 1961 to 2014. Yields and their variances depend on only three factors, yet the model exhibits features consistent with Unspanned Risk Premia (URP) and Unspanned Stochastic Volatility (USV).
This is a pre-copyedited, author-produced PDF of an article accepted for publication in Review of Finance following peer review. The version of record Feldhutter, P., Heyerdahl-Larsen, C., Illeditsch, P., Risk Premia and Volatilities in a Nonlinear Term Structure Model (2016) is available online at: https://doi.org/10.1093/rof/rfw052
Nonlinear Term Structure Models, Expected Excess Returns, Stochastic Volatility, Unspanned Risk Premia (URP), Unspanned Stochastic Volatility (USV)
Feldhütter, P., Heyersahl-Larsen, C., & Illeditsch, P. K. (2016). Risk Premia and Volatilities in a Nonlinear Term Structure Model. Review of Finance, http://dx.doi.org/10.1093/rof/rfw052
Date Posted: 25 October 2018
This document has been peer reviewed.