Estimating Two-factor Model Of The Short Interest Rate

Interest rates as one of the most basic economic variables, is the basis for asset pricing,financial product design, hedging and risk management, arbitrage and investment. Withthe rapid development of China’s bond market and interest rate liberalization, there aremore and more researches on the term structure of interest rates. And it is a basic problemto estimate parameters of the interest rate models in the financial sector.This article focuses on the EMM estimation method of two-factor continuous-timestochastic volatility model, in which using the SNP density as the EMM estimatedauxiliary model. The paper considers EMM estimation of the two-factor model usingweekly observations on the U.S.3-month T-Bill rate, in which assumed the data obey thetwo-facYTW RTdeQ, aSd Y eSeXYNRaYe Y e RTdeQ’X UaWaReYeW. WTR Y e eXYNRaYed WeXYQYX, Y etwo-factor interest rate models dTS’Y [eQQ fNY Y e XeQecYed daYa. TT fYWY eW XYYd] Y e effecYof the EMM estimates, the paper does EMM estimation of the model using the data fromthe Monte Carlo method simulation to the two-factor model, the results show that theEMM estimation works well.Finally, to contrastive analysis the effect of parameter estimations of the two-factorinterest rate model using the GMM method and EMM method, this paper use the MonteCarlo method to simulate500sets of data given a set of model parameters, and thenestimate the parameters corresponding to each set of data using EMM method, at last drawthe distribution of the parameter estimates. Compare with the result of Travis RA Sapp(2009) which using GMM method, it shows that the effects of the GMM and EMM havetheir own advantages and disadvantages, but overall EMM method is preferences.