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Multi-Lag Term Structure Models with Stochastic Risk Premia

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  • Alain Monfort

    (Crest)

  • Fulvio Pegoraro

    (Crest)

Abstract

In this paper we propose a family of discrete-time term structure models where we specify a Gaussian autoregressiveof order p > 1 historical and risk-neutral dynamics for the factor (xt), considered as a latent or observable variable: inthe second case the factor is a vector of several yields. We present the Gaussian AR(p) Factor-Based Term StructureModel in which the stochastic discount factor (SDF) for the period (t, t + 1) is specified as an exponential-affinefunction of xt+1, the factor risk-correction coefficient is stochastic, and the associated yield-to-maturity formulaat time t is an affine function of Xt = (xt, . . . , xt-p+1)0. We propose the Moving Average (or Heath, Jarrow andMorton) characterization of the yield and short-term forward rate processes, under the risk-neutral and the S-forwardprobability : this representation gives the possibility to exactly replicate the currently-observed yield curve. We alsostudy the problem of matching the theoretical and the currently-observed market term structure by means of theExtended AR(p) approach. We present the Gaussian VAR(p) Factor-Based Term Structure Model, generalizing thepreviously mentioned results to the multivariate framework.

Suggested Citation

  • Alain Monfort & Fulvio Pegoraro, 2006. "Multi-Lag Term Structure Models with Stochastic Risk Premia," Working Papers 2006-29, Center for Research in Economics and Statistics.
    • Handle: RePEc:crs:wpaper:2006-29
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    References listed on IDEAS

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    Cited by:

    1. Alain Monfort & Jean-Paul Renne, 2013. "Default, Liquidity, and Crises: an Econometric Framework," Journal of Financial Econometrics, Oxford University Press, vol. 11(2), pages 221-262, March.
    2. H. Bertholon & A. Monfort & F. Pegoraro, 2008. "Econometric Asset Pricing Modelling," Journal of Financial Econometrics, Oxford University Press, vol. 6(4), pages 407-458, Fall.
    3. Monfort, A. & Pegoraro, F., 2007. "Switching VARMA Term Structure Models - Extended Version," Working papers 191, Banque de France.

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    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • G1 - Financial Economics - - General Financial Markets

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