University of the Basque Country, Department of Foundations of Economic Analysis II
Abstract
Published as an article in: Studies in Nonlinear Dynamics & Econometrics, 2004, vol. 8, issue 3, article 6.In an economy with multiple sources of risk, the short-term interest rate does not capture all the information that determines the conditional distribution of bond yields. This is also true for path-dependent term structure models. In either case, the current short rate level is not a sufficient statistic for the conditional density of future short rates. This paper studies the empirical relevance of both issues from a time-series nonparametric perspective. The analysis is formulated as a test for the dependence of the short rate drift and diffusion on variables other than the short rate, and exploits Ait-Sahalia, Bickel, and Stocker (2001) dimension reduction method. The paper explores the finite sample performance of the method and applies the test to US interest rate data. Results
reject a single-factor Markovian model, although conclusions are sensitive to the
choice of additional conditioning variables.Javier Gil-Bazo thanks funding from Ministerio de Educación y Cultura, grant SEC2001-1169. Gonzalo Rubio acknowledges the financial support provided by Ministerio de Ciencia y Tecnología, grant BEC2001-0636, and by Fundación BBVA, research grant 1-BBVA 0004.321-15466/2002