Modelling and Forecasting Short-Term Interest Rate Volatility: A Semiparametric Approach

• This paper employs a semiparametric procedure to estimate the diffusion process of short-term interest rates. The Monte Carlo study shows that the semiparametric approach produces more accurate volatility estimates than models that accommodate asymmetry, levels e¤ect and serial dependence in the conditional variance. Moreover, the semiparametric approach yields robust volatility estimates even if the short rate drift function and the underlying innovation distribution are misspeci.ed. Empirical investigation with the U.S. three-month Treasury bill rates suggests that the semipara-metric procedure produces superior in-sample and out-of-sample forecast of short rate changes volatility compared with the widely used single-factor diffusion models. This forecast improvement has implications for pricing interest rate derivatives.

Ämnesord

SAMHÄLLSVETENSKAP  -- Ekonomi och näringsliv -- Nationalekonomi (hsv//swe)

SOCIAL SCIENCES  -- Economics and Business -- Economics (hsv//eng)

SAMHÄLLSVETENSKAP  -- Ekonomi och näringsliv -- Företagsekonomi (hsv//swe)

SOCIAL SCIENCES  -- Economics and Business -- Business Administration (hsv//eng)

Nyckelord

Volatility esti- mation

GARCH modelling

Nonparametric method

Forecasts

Interest rates; GARCH modelling; Nonparametric method; Volatility estimation; Forecasts

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