A plausible model of yield curve dynamics
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We present a simple model of yield curve dynamics which satisfies key criteria of plausibility. Specifically, yields are non-negative and the Sharpe ratio of a mean-variance optimal bond portfolio has a reasonable magnitude. The model matches stylized data features, in particular long-run moments of yields and excess returns.
KeywordsTerm structure modeling Sharpe ratios
JEL ClassificationE43 G12
I am grateful to the editor Markus Schmid and two anonymous referees, and also to Patrick Caldon, Ralph Koijen, and Harald Uhlig for helpful and constructive comments. Jing Cynthia Wu was kind enough to answer my questions about the code in Bauer et al. (2012), enabling the comparison in Sect. 5.
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