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The Academy of Economic Studies The Faculty of Finance, Insurance, Banking and Stock Exchange Doctoral School of Finance and Banking. -comparison of Central and Eastern European countries-. Short Term Interest Rate and Market Price of Risk Evolution. MSc. Student: Hirtan Mihai Alexandru
The Academy of Economic StudiesThe Faculty of Finance, Insurance, Banking and Stock Exchange
Doctoral School of Finance and Banking
-comparison of Central and Eastern European countries-
MSc. Student: Hirtan Mihai Alexandru
Coordinator: PhD. Professor Moisa Altar
July 2010, Bucharest
Vasicek (1977), Cox, Ingersoll & Ross (1985)
Ho-Lee (1986), Hull-White (1990), Heath, Jarrow & Morton (1992)
today’s term structure of IR is an input
designed to be consistent with today’s term structure of IR
easy to calibrate
drift of the short rate is , in general, time dependent
Chan et al. (CKLS1992) show that volatility of the IR is highly sensitive to the level of r . Models with elasticity >1 capture the dynamics of the IR better than those with values lower than the unit.
Chapman et al. (1999) tested successfully the substitution of the short term rate with 3 month and 1 month Treasury Bills, avoiding the microstructure problems.
Starting from Heath, Jarrow, Morton model (1992), Mahdavi found:
is the derivative of with respect to T evaluated at T=t
when arbitrage opportunities are ruled out, the expected change in the riskless rate at time t is equal to the current slope of forward curve (observable at time t) , minus a risk premium
MPR is defined:
The MPR becomes:
the vector of of parameters
the vector of instrumental variables
GMM uses the orthogonality condition
to estimate the parameters
nr. of orthogonality conditions, 10 > nr. parameters to be estimated, 7 the efficient estimates are obtained by minimizing the objective function
WT is a positive-definite symmetric weighting matrix
autocorrelation coefficients until the 6-th lag
Even if IR have poor results on stationarity tests like ADF, PP, KPSS and correlogram analysis – the problem is arguable:
Similar to the results reported by Tse(1995), Nowman(1998), Kazemi, Mahdavi, Salazar(2004) and Mahdavi(2008) we find that no single model can explain the IR process in all Eastern European countries considered
The drift of the IR for Romania, Czech Republic and Poland has a quadratic structure in r. Though, the fact that the drift pulls back the short term rate into the middle region when it goes for extreme values could lead to globally stationary processes. This is according to the findings of Ait-Sahalia(1996) and Ahn&Gao (1999)
Romania - The MPR is negative and relatively stable around the value of -0,4 suggesting a rational, risk averse behavior of investors. Negative peaks showing the moments of fear appeared in delicate situations like the speculative attack from September 2008 which had a strong impact across the entire region
Czech Republic&Hungary: even though there are moments when the MPR is rising and falling it seems that is returning to a middle range, showing a relative constant attitude towards risk. The average lambda is 0,2 for Czech Republic and 13,5 for Hungary, the last one being the largest one as an absolute value among the analyzed countries.
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