Abstract
Most reported stochastic volatility (SV) model for interest rates only deals with an AR specification for the latent factor process. We show in this paper the technical details for specifying the SV model for interest rates that includes an ARMA structure, a jump component and additional exogenous variables for the latent factor process. We demonstrate the efficacy of this approach with an application to the US short-term interest rate data. We find that the elasticity parameter of the variance is closer to 0.5, i.e., similar to that of the Cox–Ingersoll–Ross (1985) model of interest rates. This is quite a contrast to the finding Chan et al. [Chan, KC, GA Karolyi, F Longstaff and A Sanders (1992). The volatility of short-term interest rates: An empirical comparison of alternative models of term structure of interest rates, Journal of Finance, 47, 1209–1227]. who found the elasticity to be close to 1.5.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
