An International Examination of Affine Term Structure Models and the Expectations Hypothesis

Huarong Tang, Yihong Xia
2007 Journal of Financial and Quantitative Analysis  
We examine the yield curve behavior and the relative performance of affine term structure models using government bond yield data from Canada, Germany, Japan, UK, and US. We find strong predictability of forward rates for excess bond returns across all five countries but fail to reject the expectations hypothesis in three out of the five countries. A three-factor model is sufficient to capture movements in the yield curve of Canada, Japan, UK, and US, but may not be enough for Germany. An
more » ... r Germany. An exhaustive comparison among affine term structure models with no more than three factors reveals that the threefactor essential affine model (A 1 (3)E) with only one factor affecting the volatility of the short rate but with all three factors affecting the price of risk performs best in all five countries. Simulations provide inconclusive evidence on whether this best affine model can successfully generate the rich yield curve behavior observed in the data.
doi:10.1017/s0022109000002180 fatcat:6shybp245bcwzdw4y2qxnqbuyy