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A Type of HJM Based Affine Model: Theory and Empirical Evidence

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  • Haitao Li
  • Xiaoxia Ye

Abstract

In this paper a type of Heath, Jarrow and Morton (1992) (HJM) based affine model is derived theoretically. This type of affine model is obtained by applying Linear Realization Theory to construct Finite Dimensional Realizations (FDRs) of the Gaussian HJM model. The algorithms of constructing Standard Observable Canonical Realization and Jordan Canonical Realization are introduced sequentially. And it is shown that the commonly adopted FDR is actually Jordan Canonical Realization. The empirical results show that a two-factor model of this type provides great fit to the term structure of interest rates data. The resulting state variables have clear economic interpretations. And it is found that the short end of the term structure can be precisely considered as a “medium-run factor” which uniformly shifts the yield curve. This finding has an important implication for bond portfolios management, and also helps us better understand the interactions between macro-economy and term structure dynamics.

Suggested Citation

  • Haitao Li & Xiaoxia Ye, 2013. "A Type of HJM Based Affine Model: Theory and Empirical Evidence," Working Papers 2013-10-14, Wang Yanan Institute for Studies in Economics (WISE), Xiamen University.
    • Handle: RePEc:wyi:wpaper:002014
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    More about this item

    Keywords

    Affine Term Structure Model; HJM; Finite Dimensional Realization; Linear Realization Theory; State Space Framework; Macro-economy;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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