Tuesday, October 11th @ 11:00-12:30 PM (639 Evans Hall)
Some Empirical Properties of a Bounded Interest Rate Model
Bjorn Flesaker, Adjunct Professor at Courant Institute of Mathematical Sciences, NYU
We consider the two-factor version of a family of time-homogeneous interest rate models introduced by Cairns (Math Finance, 2004) in the Flesaker-Hughston positive interest framework. Specifically, we calibrate the model to cross-sectional USD swap and swaption market data, and we compare the corresponding model implied dynamics to that of the swap market rates via PCA. We investigate whether allowing a non-zero lower bound improves the model fit. The model dynamics are reformulated as a two-dimensional Ito process for the short rate and the consol rate (the par yield on a bond with no finite maturity date) in order to relate it to the influential Brennan-Schwartz model of the late 1970s. As a final digression, we explore the natural space of rates that live between the short rate and the consol rate.