Empirical performance of Gaussian affine dynamic term structure models in the presence of autocorrelation misspecification bias
Recently, several authors have documented the presence of estimation bias in Gaussian affine dynamic term structure models (GADTSM). However, only a few applications involving its impact on the empirical performance of GADTSM exist in the extant literature, and these studies focus solely on discrete-time vector autoregressive (VAR) based GADTSM and concentrate on issues of small-sample bias and persistence. In this paper, we provide a comprehensive investigation of this issue that includes the estimation of both discrete-time VAR based GADTSM and continuous-time GADTSM at multiple data frequencies through a unique empirical design and two Monte Carlo simulation experiments, within which we construct estimation bias from the serial correlation in yield pricing errors. Our findings show that, although, empirical performance of all studied GADTSM are severely impacted by estimation bias, discrete-time GADTSM are more severely impacted by estimation bias than continuous-time GADTSM. Building on theoretical arguments developed in previous works, we attribute this finding to the strong dependence of discrete-time VAR based GADTSM on the ordinary least squares econometric technique relative to the continuous-time GADTSM for which general maximum likelihood estimation is more suitable.
KeywordsDynamic term structure model Autocorrelation misspecification Estimation bias Model performance
JEL ClassificationE43 C52 C58 E47
I would like to thank Chris Lamoureux, A.D. Amar and seminar participants at the 2015 Financial Management Association Annual meetings held in Orlando, Florida. I would also like to especially thank the editor, Cheng Few Lee, the associate editors, and anonymous referees who are all associated with the Review of Quantitative Finance and Accounting for helpful and insightful comments that greatly improved the paper.
- Duffee G (2011) Forecasting with the term structure: the role of no-arbitrage restrictions. Johns Hopkins University (unpublished working paper)Google Scholar
- Goliński A, Spencer P (2017) The advantages of using excess returns to model the term structure. J Financ Econ. doi: 10.1016/j.jfineco.2017.05.001
- Yang X, Cheng J (2010) A data-driven approach for building macroeconomic decision support system. In: 2010 institute of electrical and electronics engineers international conference on systems, man, and cybernetics, October 13, 2010, pp 1054–1061Google Scholar