Bilinear Term Structure Models

A.M.E. Monfort

Research output: Contribution to journalArticleAcademicpeer-review

Abstract

The Gaussian Affine Term Structure Model (ATSM) introduced by Duffie and Kan is often used in finance to price derivatives written on interest rates or to compute the reserve to hedge a portfolio of credits (CreditVaR), and in macroeconomic applications to study the links between real activity and financial variables. However, a standard three-factor ATSM, for instance, implies a deterministic affine relationship between any set of four rates, with different times-to-maturity, and these relationships are not observed in practice. In this paper, we introduce a new class of affine term structure models, called Bilinear Term Structure Model (BTSM). This extension breaks down the deterministic relationships between rates in structural factor models by introducing lagged factor values, and the linear dependence by considering quadratic effects of the factors.

Original languageEnglish
Pages (from-to)1-19
Number of pages19
JournalMathematical Finance
Volume21
Issue number1
DOIs
Publication statusPublished - 1 Jan 2011

Keywords

  • affine term structure
  • quadratic term structure
  • monetary policy
  • credit risk
  • Wishart process
  • bilinear process
  • UNSPANNED STOCHASTIC VOLATILITY
  • INTEREST-RATES
  • AFFINE MODELS
  • RISK PREMIA
  • FORECASTS
  • MORTALITY
  • DYNAMICS
  • GROWTH

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