Adaptive Interest Rate Modelling

SFB 649 Discussion Paper 2010-029

30 Pages Posted: 9 Jan 2017

See all articles by Mengmeng Guo

Mengmeng Guo

Humboldt University of Berlin

Wolfgang Karl Härdle

Blockchain Research Center Humboldt-Universität zu Berlin; Charles University; National Yang Ming Chiao Tung University; Asian Competitiveness Institute

Date Written: May 21, 2010

Abstract

A good description of the dynamics of interest rates is crucial to price derivatives and to hedge corresponding risk. Interest rate modelling in an unstable macroeconomic context motivates one factor models with time varying parameters. In this paper, the local parameter approach is introduced to adaptively estimate interest rate models. This method can be generally used in time varying coefficient parametric models. It is used not only to detect the jumps and structural breaks, but also to choose the largest time homogeneous interval for each time point, such that in this interval, the coefficients are statistically constant. We use this adaptive approach and apply it in simulations and real data. Using the three month treasure bill rate as a proxy of the short rate, we find that our method can detect both structural changes and stable intervals for homogeneous modelling of the interest rate process. In more unstable macro-economy periods, the time homogeneous interval can not last long. Furthermore, our approach performs well in long horizon forecasting.

Keywords: CIR model, Interest rate, Local parametric approach, Time homogeneous interval, Adaptive statistical techniques

JEL Classification: E44, G12, G32, N22

Suggested Citation

Guo, Mengmeng and Härdle, Wolfgang Karl, Adaptive Interest Rate Modelling (May 21, 2010). SFB 649 Discussion Paper 2010-029, Available at SSRN: https://ssrn.com/abstract=2894265 or http://dx.doi.org/10.2139/ssrn.2894265

Mengmeng Guo

Humboldt University of Berlin ( email )

Unter den Linden 6
Berlin, AK Berlin 10099
Germany

Wolfgang Karl Härdle (Contact Author)

Blockchain Research Center Humboldt-Universität zu Berlin ( email )

Unter den Linden 6
Berlin, D-10099
Germany

Charles University ( email )

Celetná 13
Dept Math Physics
Praha 1, 116 36
Czech Republic

National Yang Ming Chiao Tung University ( email )

No. 1001, Daxue Rd. East Dist.
Hsinchu City 300093
Taiwan

Asian Competitiveness Institute ( email )

Singapore

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