Econometrics of yield spreads in the money market

a note

Sumon Bhaumik, D. Coondoo

Research output: Contribution to journalArticle

Abstract

The literature on bond markets and interest rates has focused largely on the term structure of interest rates, specifically, on the so-called expectations hypothesis. At the same time, little is known about the nature of the spread of the interest rates in the money market beyond the fact that such spreads are generally unstable. However, with the evolution of complex financial instruments, it has become imperative to identify the time series process that can help one accurately forecast such spreads into the future. This article explores the nature of the time series process underlying the spread between three-month and one-year US rates, and concludes that the movements in this spread over time is best captured by a GARCH(1,1) process. It also suggests the use of a relatively long term measure of interest rate volatility as an explanatory variable. This exercise has gained added importance in view of the revelation that GARCH based estimates of option prices consistently outperform the corresponding estimates based on the stylized Black-Scholes algorithm.
Original languageEnglish
Pages (from-to)645-653
Number of pages9
JournalApplied Financial Economics
Volume13
Issue number9
DOIs
Publication statusPublished - 2003

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Yield spread
Econometrics
Money market
Generalized autoregressive conditional heteroscedasticity
Interest rates
Exercise
Option prices
Black-Scholes
Term structure of interest rates
Expectations hypothesis
Interest rate volatility
Bond market
Financial instruments

Cite this

Bhaumik, Sumon ; Coondoo, D. / Econometrics of yield spreads in the money market : a note. In: Applied Financial Economics. 2003 ; Vol. 13, No. 9. pp. 645-653.
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Econometrics of yield spreads in the money market : a note. / Bhaumik, Sumon; Coondoo, D.

In: Applied Financial Economics, Vol. 13, No. 9, 2003, p. 645-653.

Research output: Contribution to journalArticle

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