Abstract #300030

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JSM 2003 Abstract #300030
Activity Number: 68
Type: Invited
Date/Time: Monday, August 4, 2003 : 8:30 AM to 10:20 AM
Sponsor: International Chinese Statistical Association
Abstract - #300030
Title: Time-Dependent Diffusion Models for Term Structure Dynamics
Author(s): Chunming Zhang*+
Companies: University of Wisconsin
Address: 1210 W Dayton St., Madison, WI, 53706-1613,
Keywords: diffusion model ; kernel regression ; nonparametric goodness-of-fit
Abstract:

In an effort to capture the time variation on the instantaneous return and volatility functions, a family of time-dependent diffusion processes are introduced to model the term structure dynamics. This allows one to examine how the instantaneous return and price volatility change over time and price level. Nonparametric techniques, based on kernel regression, are used to estimate the time-varying coefficient functions in the drift and diffusion. The newly proposed semiparametric model includes most of the well-known short-term interest rate models, such as those proposed by Cox, et al. and Chan, et al. It can be used to test the goodness-of-fit of these famous time- homogeneous short rate models. The new method complements the time-homogeneous nonparametric estimation techniques of Stanton and Fan and Yao, and is shown through simulations to truly capture the heteroscedasticity and time-inhomogeneous structure in volatility. A family of new statistics are introduced to test whether the time-homogeneous models adequately fit interest rates for certain period of economy. We illustrate the new methods by using weekly three-month Treasury Bill data.

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