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Interest Rate Volatility and the Term Structure: A Two‐Factor General Equilibrium Model
Abstract
We develop a two‐factor general equilibrium model of the term structure. The factors are the short‐term interest rate and the volatility of the short‐term interest rate. We derive closed‐form expressions for discount bonds and study the properties of the term structure implied by the model. The dependence of yields on volatility allows the model to capture many observed properties of the term structure. We also derive closed‐form expressions for discount bond options. We use Hansen's generalized method of moments framework to test the cross‐sectional restrictions imposed by the model. The tests support the two‐factor model.
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Cites
Engle, R. F. (1982) · Econometrica · doi:10.2307/1912773 · Cited by 20,795
Cited by
Affine processes and applications in finance
Duffie, D., Filipović, D., & Schachermayer, W. (2003) · The Annals of Applied Probability · doi:10.1214/aoap/1060202833 · Cited by 1,041
Arbitrage Theory in Continuous Time
Björk, T. (2004) · doi:10.1093/0199271267.001.0001 · Cited by 940
Ang, A., & Piazzesi, M. (1999) · SSRN Electronic Journal · doi:10.2139/ssrn.194748 · Cited by 543
Fundamental Economic Variables, Expected Returns, and Bond Fund Performance
ELTON, E. J., GRUBER, M. J., & BLAKE, C. R. (1995) · The Journal of Finance · doi:10.1111/j.1540-6261.1995.tb04056.x · Cited by 403
Metadata
- Authors
- LONGSTAFF, F. A., & SCHWARTZ, E. S.
- Venue
- The Journal of Finance
- Publisher
- Wiley
- Published
- 1992-09
- Volume
- 47
- Issue
- 4
- Pages
- 1259-1282
- ISSN
- 0022-1082 (ISSN-L)
- 1540-6261
- OpenAlex
- W2170131042
- Cited by
- 976
- References
- 1
- FWCI
- 44.99
- Type
- journal article
- Language
- en
- Open access
- closed
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- LONGSTAFF, F. A., & SCHWARTZ, E. S. (1992). Interest Rate Volatility and the Term Structure: A Two‐Factor General Equilibrium Model. The Journal of Finance. https://doi.org/10.1111/j.1540-6261.1992.tb04657.x
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