CRIF Working Paper No. 02014

Design and Estimation of Quadratic Term Structure Models

Title: Design and Estimation of Quadratic Term Structure

Authors: Markus Leippold (University of Zurich) 

              Liuren Wu (Fordham University)

Contact: wu@fordham.edu

Keywords: Quadratic model, term structure, positive interest rates, humps, expectation hypothesis, GMM, caps and floors.

JEL Classification: G12, G13, E43

Abstract: We consider the design and estimation of quadratic term structure models. We start with a list of stylized facts on interest rates and interest rate derivatives, classified into three layers: (1) general statistical properties, (2) forecasting relations, and (3) conditional dynamics. We then investigate the implications of each layer of property on model design and strive to establish a mapping between evidence and model structures. We calibrate a two-factor model that approximates these three layers of properties well, and illustrate how the model can be applied to pricing interest rate derivatives. 

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Comments: The paper is forthcoming in European Finance Review.