Empirical tests of short-term interest rate models: a nonparametric approach

Abstract

Short-term interest rate models are investigated using daily data for both the US and Japan over the period October 1989 to January 1994. A nonparametric method is used to estimate the conditional mean and variance (volatility) of the short-term interest rate changes and to estimate their partial derivatives. In contrast to the Japanese interest rate, US interest rates exhibit mean reverting drift which is found to be nonlinear. The conditional variances of both US and Japanese interest rate changes are found to depend on the level of the interest rate nonlinearly.