Conditional volatility in affine term-structure models

Evidence from Treasury and swap markets

K. Jacobs, L. Karoui

Research output: Contribution to journalArticleScientificpeer-review

Abstract

We study the ability of three-factor affine term-structure models to extract conditional volatility using interest rate swap yields for 1991–2005 and Treasury yields for 1970–2003. For the Treasury sample, the correlation between model-implied and EGARCH volatility is between 60% and 75%. For the swap sample, this correlation is rather low or negative. We find that these differences in model performance are primarily due to the timing of the swap sample, and not to institutional differences between swap and Treasury markets. We conclude that the ability of multifactor affine models to extract conditional volatility depends on the sample period, but that overall these models perform better than has been argued in the literature.
Original languageEnglish
Pages (from-to)288-318
JournalJournal of Financial Economics
Volume91
Issue number3
Publication statusPublished - 2009

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Conditional volatility
Affine term structure models
Swaps
Affine model
Factors
Interest rate swaps
Multi-factor
Institutional differences

Cite this

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Conditional volatility in affine term-structure models : Evidence from Treasury and swap markets. / Jacobs, K.; Karoui, L.

In: Journal of Financial Economics, Vol. 91, No. 3, 2009, p. 288-318.

Research output: Contribution to journalArticleScientificpeer-review

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N2 - We study the ability of three-factor affine term-structure models to extract conditional volatility using interest rate swap yields for 1991–2005 and Treasury yields for 1970–2003. For the Treasury sample, the correlation between model-implied and EGARCH volatility is between 60% and 75%. For the swap sample, this correlation is rather low or negative. We find that these differences in model performance are primarily due to the timing of the swap sample, and not to institutional differences between swap and Treasury markets. We conclude that the ability of multifactor affine models to extract conditional volatility depends on the sample period, but that overall these models perform better than has been argued in the literature.

AB - We study the ability of three-factor affine term-structure models to extract conditional volatility using interest rate swap yields for 1991–2005 and Treasury yields for 1970–2003. For the Treasury sample, the correlation between model-implied and EGARCH volatility is between 60% and 75%. For the swap sample, this correlation is rather low or negative. We find that these differences in model performance are primarily due to the timing of the swap sample, and not to institutional differences between swap and Treasury markets. We conclude that the ability of multifactor affine models to extract conditional volatility depends on the sample period, but that overall these models perform better than has been argued in the literature.

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JO - Journal of Financial Economics

JF - Journal of Financial Economics

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