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A factor analysis of volatility across the term structure: the Spanish case

Author

Listed:
  • Sonia Benito

    (Dpto. de Economía Cuantica, Universidad Complutense)

  • Alfonso Novales Cinca

    (Dpto. de Fundamentos de Análisis Económico II, Universidad Complutense)

Abstract

We show how the term structure of volatilities for zero-cupon interest rates from the Spanish secondary debt market can be explained by a reduced number of factors. This factor representation can be used to produce time series volatilities across the whole term structure. As an alternative, volatilities can also be derived from a factor model for interest rates themselves. We find evidence contrary to the hypothesis that these two procedures lead to statistically equivalent time series, so that choosing the right model to estimate volatility is far from trivial. The volatility factor model fits univariate EGARCH volatility time series much better than the interest rate factor model does. However, observed differences seem to be of little consequence for VaR estimation on zero coupon bonds.

Suggested Citation

  • Sonia Benito & Alfonso Novales Cinca, 2005. "A factor analysis of volatility across the term structure: the Spanish case," Documentos de Trabajo del ICAE 0502, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
    • Handle: RePEc:ucm:doicae:0502
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    References listed on IDEAS

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    3. Elton, Edwin J & Gruber, Martin J & Michaely, Roni, 1990. "The Structure of Spot Rates and Immunization," Journal of Finance, American Finance Association, vol. 45(2), pages 629-642, June.
    4. Engsted, Tom & Tanggaard, Carsten, 1994. "Cointegration and the US term structure," Journal of Banking & Finance, Elsevier, vol. 18(1), pages 167-181, January.
    5. Hall, Anthony D & Anderson, Heather M & Granger, Clive W J, 1992. "A Cointegration Analysis of Treasury Bill Yields," The Review of Economics and Statistics, MIT Press, vol. 74(1), pages 116-126, February.
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    analysis of volatility.;

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