Finance and Economics Discussion Series (FEDS)
August 2003
Itô Conditional Moment Generator and the Estimation of Short Rate Processes
Hao Zhou
Abstract:
This paper exploits the Itô's formula to derive the conditional moments vector for the class of interest rate models that allow for nonlinear volatility and flexible jump specifications. Such a characterization of continuous-time processes by the Ito Conditional Moment Generator noticeably enlarges the admissible set beyond the affine jump-diffusion class. A simple GMM estimator can be constructed based on the analytical solution to the lower order moments, with natural diagnostics of the conditional mean, variance, skewness, and kurtosis. Monte Carlo evidence suggests that the proposed estimator has desirable finite sample properties, relative to the asymptotically efficient MLE. The empirical application singles out the nonlinear quadratic variance as the key feature of the U.S. short rate dynamics.
Keywords: Itô conditional moment menerator, short-term interest rate, jump-diffusion process, quadratic variance, generalized method of moments, Monte Carlo study.
PDF: Full Paper
Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.