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In Rememberance: World Trade Center (WTC)

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An Empirical Comparison of Alternative models of the Short-term Interest Rate

by K. C. Chan of Ohio State University,
G. Andrew Karolyi of Ohio State University,
Francis A. Longstaff  of Ohio State University, and
Anthony B. Sanders of Ohio State University

July 1992

Abstract: We estimate and compare a variety of continuous-time models of the short-term riskless rate using the Generalized Method of Moments. We find that the most successful models in capturing the dynamics of the short-term interest rate are those that allow the volatility of interest rate changes to be highly sensitive to the level of the riskless rate. A number of well-known models perform poorly in the comparisons because of their implicit restrictions on term structure volatility. We show that these results have important implications for the use of different term structure models in valuing interest rate contingent claims and in hedging interest rate risk.

Published in: Journal of Finance, Vol. 47. No. 3, (July 1992), pp. 1209-1227.

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