Testing Linearity in Term Structures

Peroni, Chiara (2009): Testing Linearity in Term Structures.

Abstract

Recent empirical studies suggests that affine models, a popular framework to analyse term structures of interest rates, are misspecified. This evidence is mainly based on time series properties of the data. This article re-examines this controversy, by investigating both cross-sectional and dynamic properties of affine models. To do so, it applies robust non-parametric techniques to two different sets of financial data, which contain information on the UK and US yield curve. The analysis shows the strong non-linearity in the relationship of yields to the US and UK short rate. The non-linear pattern is concave in the state variable, and increasing with respect to the maturity, for both countries. Linear and non-linear specifications are then compared by means of a formal statistical criterion, the Generalised Likelihood-Ratio test statistics, which confirms evidence against the linear specification.

• Item Type: MPRA Paper
• Language: English
• Keywords: interest rates; term structure; affine models; non-linearity; non-parametric regression.
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C14 - Semiparametric and Nonparametric Methods: General

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