TY - JOUR
T1 - Unspanned stochastic volatility in the linear-rational square-root model: Evidence from the Treasury market
AU - Hansen, Jorge
PY - 2025/2
Y1 - 2025/2
N2 - This study examines the ability of the linear-rational square-root model to simultaneously capture cross-sectional and time-series dynamics of bond yields and their variances. The preferred model specification comprises five factors, two of which are not spanned by the yield curve, introducing unspanned stochastic volatility (USV). This specification provides a close in-sample fit to yields and yield variances, emphasizing the need for USV. Out-of-sample testing demonstrates low variance forecast errors. The specification provides evidence of USV in conditional yield variance and bond risk premia, linked to macroeconomic uncertainty.
AB - This study examines the ability of the linear-rational square-root model to simultaneously capture cross-sectional and time-series dynamics of bond yields and their variances. The preferred model specification comprises five factors, two of which are not spanned by the yield curve, introducing unspanned stochastic volatility (USV). This specification provides a close in-sample fit to yields and yield variances, emphasizing the need for USV. Out-of-sample testing demonstrates low variance forecast errors. The specification provides evidence of USV in conditional yield variance and bond risk premia, linked to macroeconomic uncertainty.
KW - Interest rate model
KW - Treasury market
KW - Unscented Kalman filter
KW - Unspanned stochastic volatility
KW - Unspanned risk premia
UR - http://www.scopus.com/inward/record.url?scp=85212312256&partnerID=8YFLogxK
U2 - 10.1016/j.jbankfin.2024.107354
DO - 10.1016/j.jbankfin.2024.107354
M3 - Journal article
SN - 0378-4266
VL - 171
JO - Journal of Banking & Finance
JF - Journal of Banking & Finance
M1 - 107354
ER -