Drift and Diffusion Function Specification for Short-Term Interest Rates

Author

Myoung-jae LEE, Singapore Management UniversityFollow
Wen Juan LI, University of Tsukuba

Publication Type

Journal Article

Version

publishedVersion

Publication Date

3-2005

Abstract

Various stochastic differential equation models for short rates (r_t) have been proposed, where the change (Δr_t = r_t−r_t−1) is modeled as a sum of drift and diffusion terms depending on r_t−1. These models, however, have some shortcomings. First, the same model may not apply to all countries. Second, the drift and diffusion may depend not only on r_t−1 but also on further lags. Third, not just the own lagged rates, but also other countries' rates may matter. These questions are empirically analyzed for six major countries with the following findings. First, there are considerable differences in drift and diffusion across the countries. Second, the drift and diffusion often depend on r_t−2 (and r_t−3). Third, foreign rates exert substantial effects.

Keywords

Short rate, Diffusion, Spatial correlation

Discipline

Econometrics

Research Areas

Econometrics

Publication

Economics Letters

Volume

86

Issue

3

First Page

339

Last Page

346

ISSN

0165-1765

Identifier

10.1016/j.econlet.2004.09.002

Publisher

Elsevier

Citation

LEE, Myoung-jae and LI, Wen Juan. Drift and Diffusion Function Specification for Short-Term Interest Rates. (2005). Economics Letters. 86, (3), 339-346.
Available at: https://ink.library.smu.edu.sg/soe_research/177

Creative Commons License

This work is licensed under a Creative Commons Attribution-NonCommercial-No Derivative Works 4.0 International License.

Additional URL

https://doi.org/10.1016/j.econlet.2004.09.002