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Time-Varying Risk Premia In Emerging Markets: Explanation By A Multi-Factor Affine Term Structure Model

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  • CAIO IBSEN RODRIGUES DE ALMEIDA

    (IBMEC-RJ, and Department of Mathematics, Stanford University, Stanford, CA 94305-2125, USA)

Abstract

From the empirical viewpoint, the Expectation Hypothesis Theory (EHT) of the term structure of interest rates has been extensively tested and rejected for US term structure data. Dai and Singleton [6] show that under the settings of Affine term structure models it is possible that one matches both the historical term structure dynamics and capture an important stylized fact that have contradicted the EHT: Time-varying risk premia. In emerging markets, economic conditions tend to be much less stable than in developed markets. For this reason, if risk premia is dynamic in such markets, intuition would suggest that it is more volatile than in developed markets, implying a stronger statistical rejection of the EHT. In this paper, we verify the robustness of Dai and Singleton's results under these more extreme market conditions. We estimate an arbitrage free Affine Gaussian model for the term structure of swaps in the Brazilian market. We propose an extensive empirical analysis which consists on: defining the optimal number of factors to be used in the model, estimating the model, giving interpretation to the state variables in terms of risk factors, and studying the model implied risk premia. In the end, we propose an application for risk management of interest rates futures portfolios.

Suggested Citation

  • Caio Ibsen Rodrigues De Almeida, 2004. "Time-Varying Risk Premia In Emerging Markets: Explanation By A Multi-Factor Affine Term Structure Model," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 7(07), pages 919-947.
    • Handle: RePEc:wsi:ijtafx:v:07:y:2004:i:07:n:s0219024904002748
    DOI: 10.1142/S0219024904002748
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    Citations

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    Cited by:

    1. Mordecki, Ernesto & Rodríguez, Andrés Sosa, 2021. "Country risk for emerging economies: a dynamical index proposal with a case study," Brazilian Review of Econometrics, Sociedade Brasileira de Econometria - SBE, vol. 40(2), April.
    2. Júlio Cesar Albuquerque Bastos & Gabriel Caldas Montes, 2011. "Metasde Inflação E Estrutura A Termo Das Taxas De Juros - Uma Análise Dainfluência Da Credibilidade Sobre O Spread Da Taxa De Juros De Longoprazo No Brasil," Anais do XXXVIII Encontro Nacional de Economia [Proceedings of the 38th Brazilian Economics Meeting] 142, ANPEC - Associação Nacional dos Centros de Pós-Graduação em Economia [Brazilian Association of Graduate Programs in Economics].
    3. Mr. Rodrigo Cabral & Mr. Richard Munclinger & Mr. Luiz Alves & Mr. Marco Rodriguez Waldo, 2011. "On Brazil’s Term Structure: Stylized Facts and Analysis of Macroeconomic Interactions," IMF Working Papers 2011/113, International Monetary Fund.
    4. Juan Andrés Espinosa Torres & Luis Fernando Melo Velandia & José Fernando Moreno Gutiérrez, 2014. "Estimación de la prima por vencimiento de los TES en pesos del gobierno colombiano," Borradores de Economia 12333, Banco de la Republica.
    5. Almeida, Caio Ibsen Rodrigues de, 2005. "A Note on the Relation Between Principal Components and Dynamic Factors in Affine Term Structure Models," Brazilian Review of Econometrics, Sociedade Brasileira de Econometria - SBE, vol. 25(1), May.
    6. Abdymomunov, Azamat & Gerlach, Jeffrey, 2014. "Stress testing interest rate risk exposure," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 287-301.

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