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Title:Modelling the yield curve: A two components approach PDF Logo
Authors:Hatgioannides, John
Karanasos, Menelaos
Karanassou, Marika
Issue Date:2004
Series/Report no.:Working Paper, Department of Economics, Queen Mary, University of London 519
Abstract:Using parametric return autocorrelation tests and non parametric variance ratio statistics show that the UK and US short-term interest rates are unit root processes with significant mean reverting components. Congruent with this empirical evidence, we develop a new continuous time term structure model which assumes that the dynamics of the instantaneous interest rate are given by the joint effect of a (stationary) mean reverting component and a (nonstationary) martingale component. We provide a closed-form solution for the equilibrium yield curve when the temporary component is modelled as an Ornstein-Uhlenbeck process and the permanent component is modelled as an Arithmetic Brownian motion process.
Subjects:Term structure, Mean reversion, Random walk, Brownian motion, Variance ratio, Linear regression
JEL:C20
E43
G12
Document Type:Working Paper
Appears in Collections:Working Paper Series, School of Economics and Finance, Queen Mary, University of London

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