Do bonds span volatility risk in the U.S. treasury market? A specification test for affine term structure models

Torben G. Andersen*, Luca Benzoni

*Corresponding author for this work

Research output: Contribution to journalArticle

28 Scopus citations

Abstract

We propose using model-free yield quadratic variation measures computed from intraday data as a tool for specification testing and selection of dynamic term structure models. We find that the yield curve fails to span realized yield volatility in the U.S. Treasury market, as the systematic volatility factors are largely unrelated to the cross-section of yields. We conclude that a broad class of affine diffusive, quadratic Gaussian, and affine jump-diffusive models cannot accommodate the observed yield volatility dynamics. Hence, the Treasury market per se is incomplete, as yield volatility risk cannot be hedged solely through Treasury securities.

Original languageEnglish (US)
Pages (from-to)603-653
Number of pages51
JournalJournal of Finance
Volume65
Issue number2
DOIs
StatePublished - Apr 1 2010

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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