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  • Open Daily: 10am - 10pm
    Alley-side Pickup: 10am - 7pm

    3038 Hennepin Ave Minneapolis, MN
    612-822-4611

Open Daily: 10am - 10pm | Alley-side Pickup: 10am - 7pm
3038 Hennepin Ave Minneapolis, MN
612-822-4611
Computing Arbitrage-Free Yields in Multi-Factor Gaussian Shadow-Rate Term Structure Models

Computing Arbitrage-Free Yields in Multi-Factor Gaussian Shadow-Rate Term Structure Models

Federal Reserve Board

Paperback

Business General

ISBN10: 1503223736
ISBN13: 9781503223738
Publisher: Createspace
Published: Nov 14 2014
Pages: 36
Weight: 0.24
Height: 0.07 Width: 8.50 Depth: 11.02
Language: English
This paper develops a method to approximate arbitrage-free bond yields within a term structure model in which the short rate follows a Gaussian process censored at zero (a shadow-rate model as proposed by Black, 1995). The censoring ensures that model-implied yields are constrained to be positive, but it also introduces non-linearity that renders standard bond pricing formulas inapplicable. In particular, yields are not linear functions of the underlying state vector as they are in a ne term structure models (see Piazzesi, 2010). Existing approaches towards computing yields in shadow-rate models suffer from high computational burden or low accuracy. In contrast, I show that the technique proposed in this paper is sufficiently fast for single-step estimation of a three- factor shadow-rate term structure model, and sufficiently accurate to evaluate yields to within approximately half a basis point.

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