Title: Simulating term structure of interest rates with arbitrary marginals

Authors: Andrea Consiglio; Sergio Guirreri

Addresses: Department of Statistics and Mathematics ''Silvio Vianelli'', University of Palermo, Ed. 19, Viale delle Scienze, Palermo, Italy. ' Department of Statistics and Mathematics ''Silvio Vianelli'', University of Palermo, Ed. 19, Viale delle Scienze, Palermo, Italy

Abstract: Decision models under uncertainty rely their analysis on scenarios of the economic factors. A key economic factor is the term structure of interest rates (yields). Simulation models of the yield curve usually assume that the conjugate distribution of the interest rates is lognormal. Dynamic models, like vector auto-regression, implicitly postulate that the logarithm of the interest rates is normally distributed. Statistical analyses have, however, shown that stationary transformations (yield changes) of the interest rates are substantially leptokurtic, thus posing serious doubts on the reliability of the available models. We propose in this paper a VARTA model (Biller and Nelson, 2003) to simulate term structures of the interest rates with arbitrary marginals. We will show that such an approach is able to simulate paths of the entire yield curve with distributional properties very close to those found in the empirical data.

Keywords: scenario simulation; yield curve; vector autoregressive models; fat tails; term structure; interest rates; arbitrary marginals; uncertainty.

DOI: 10.1504/IJRAM.2011.042670

International Journal of Risk Assessment and Management, 2011 Vol.15 No.4, pp.299 - 313

Received: 13 May 2010
Accepted: 12 Jan 2011
Published online: 28 Feb 2015 *

Full-text access for editors Full-text access for subscribers Purchase this article Comment on this article