On the estimation and comparison of short-rate models using the generalised method of moments

Faff, R. and Gray, P. (2006) On the estimation and comparison of short-rate models using the generalised method of moments. Journal of Banking and Finance, 30 11: 3131-3146. doi:10.1016/j.jbankfin.2005.09.016

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Author Faff, R.
Gray, P.
Title On the estimation and comparison of short-rate models using the generalised method of moments
Journal name Journal of Banking and Finance   Check publisher's open access policy
ISSN 0378-4266
Publication date 2006-11
Sub-type Article (original research)
DOI 10.1016/j.jbankfin.2005.09.016
Open Access Status File (Author Post-print)
Volume 30
Issue 11
Start page 3131
End page 3146
Total pages 16
Editor G. P. Szegoe
Place of publication Netherlands
Publisher Elsevier BV, North-Holland
Collection year 2006
Language eng
Subject C1
350301 Finance
710401 Finance and investment services
Abstract Subsequent to the influential paper of [Chan, K.C., Karolyi, G.A., Longstaff, F.A., Sanders, A.B., 1992. An empirical comparison of alternative models of the short-term interest rate. Journal of Finance 47, 1209-1227], the generalised method of moments (GMM) has been a popular technique for estimation and inference relating to continuous-time models of the short-term interest rate. GMM has been widely employed to estimate model parameters and to assess the goodness-of-fit of competing short-rate specifications. The current paper conducts a series of simulation experiments to document the bias and precision of GMM estimates of short-rate parameters, as well as the size and power of [Hansen, L.P., 1982. Large sample properties of generalised method of moments estimators. Econometrica 50, 1029-1054], J-test of over-identifying restrictions. While the J-test appears to have appropriate size and good power in sample sizes commonly encountered in the short-rate literature, GMM estimates of the speed of mean reversion are shown to be severely biased. Consequently, it is dangerous to draw strong conclusions about the strength of mean reversion using GMM. In contrast, the parameter capturing the levels effect, which is important in differentiating between competing short-rate specifications, is estimated with little bias. (c) 2006 Elsevier B.V. All rights reserved.
Keyword Business, Finance
Short-rate Model
Parameter Estimation
Mean Reversion
Term Interest-rate
Consistent Covariance-matrix
Autoregressive Time-series
Small-sample Properties
Q-Index Code C1

Document type: Journal Article
Sub-type: Article (original research)
Collections: Excellence in Research Australia (ERA) - Collection
2007 Higher Education Research Data Collection
UQ Business School Publications
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Citation counts: TR Web of Science Citation Count  Cited 5 times in Thomson Reuters Web of Science Article | Citations
Scopus Citation Count Cited 8 times in Scopus Article | Citations
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Created: Wed, 15 Aug 2007, 06:33:04 EST