Department of Economics and Business Economics

Affine Bond Pricing with a Mixture Distribution for Interest Rate Time-Series Dynamics

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  • Rp10 11

    Final published version, 704 KB, PDF document

  • Torben B. Rasmussen, Denmark
  • School of Economics and Management
Starting from the discrete-time ane term structure model by Dai, Le & Singleton
(2006), this paper proposes a Radon-Nikodym derivative which implies that factors
follow a mixture distribution under the physical measure. The model thus maintains
attractive features of an affine relation between yields and factors, while allowing for
nonlinear and non-normal time-series dynamics. Empirically the ft of the discrete-
time 3-factor ane model is found to be substantially improved by the inclusion of
two components to describe the time-series dynamics. Relative to the risk-neutral
model, the mixture model is able to let the variance of the one-period rate be higher
and faster increasing in the variance factor, and to introduce negative skewness and
positive excess kurtosis. When weights on the components depend on factors, the
model produces a speed of mean reversion and variance of the one-period rate that
both increase fast with higher levels of the yield curve. The added second component
is found to capture infrequent relatively large simultaneous shifts in direction of a yield
curve that is at a lower level, is steeper, and is more positively curved.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages54
Publication statusPublished - 2010

    Research areas

  • Term Structure, Discrete-time models, No-arbitrage pricing, Mixture models

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