Drift and diffusion function specification for short-term interest rates

Myoung-jae Lee, Wen Juan Li

Research output: Contribution to journalArticle

6 Citations (Scopus)

Abstract

Various stochastic differential equation models for short rates (rt) have been proposed, where the change (Δrt=rt-rt-1) is modeled as a sum of drift and diffusion terms depending on rt-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 rt-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 rt-2 (and rt-3). Third, foreign rates exert substantial effects.

Original languageEnglish
Pages (from-to)339-346
Number of pages8
JournalEconomics Letters
Volume86
Issue number3
DOIs
Publication statusPublished - 2005 Mar 1
Externally publishedYes

Keywords

  • Diffusion
  • Short rate
  • Spatial correlation

ASJC Scopus subject areas

  • Economics and Econometrics
  • Finance

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