A note on the long rate in factor models of the term structure

A note on the long rate in factor models of the term structure In this paper, we consider factor models of the term structure based on a Brownian filtration. We show that the existence of a nondeterministic long rate in a factor model of the term structure implies, as a consequence of the Dybvig–Ingersoll–Ross theorem, that the model has an equivalent representation in which one of the state variables is nondecreasing. For two‐dimensional factor models, we prove moreover that if the long rate is nondeterministic, the yield curve flattens out, and the factor process is asymptotically nondeterministic, then the term structure is unbounded. Finally, we provide an explicit example of a three‐dimensional affine factor model with a nondeterministic yet finite long rate in which the volatility of the factor process does not vanish over time. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Mathematical Finance Wiley

A note on the long rate in factor models of the term structure

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Publisher
Wiley
Copyright
© 2018 Wiley Periodicals, Inc.
ISSN
0960-1627
eISSN
1467-9965
D.O.I.
10.1111/mafi.12151
Publisher site
See Article on Publisher Site

Abstract

In this paper, we consider factor models of the term structure based on a Brownian filtration. We show that the existence of a nondeterministic long rate in a factor model of the term structure implies, as a consequence of the Dybvig–Ingersoll–Ross theorem, that the model has an equivalent representation in which one of the state variables is nondecreasing. For two‐dimensional factor models, we prove moreover that if the long rate is nondeterministic, the yield curve flattens out, and the factor process is asymptotically nondeterministic, then the term structure is unbounded. Finally, we provide an explicit example of a three‐dimensional affine factor model with a nondeterministic yet finite long rate in which the volatility of the factor process does not vanish over time.

Journal

Mathematical FinanceWiley

Published: Jan 1, 2018

Keywords: ; ; ;

References

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