A large part of the term structure literature interprets the first underlying factors as a level factor, a slope factor, and a curvature factor. In this paper we consider factor models interpretable as a level factor model, a level and a slope factor model, respectively. We prove that such models are compatible with no-arbitrage restrictions and the positivity of rates either under rather unrealistic conditions on the dynamic of the short term interest rate, or at the cost of explosive long-term interest rates. This introduces some doubt on the relevance of the level and slope interpretations of factors in term structure models.
Simon Dubecq and Christian Gourieroux
Classification JEL : E43, E44, G12.
Keywords : Interest Rate, Term Structure, Affine Model, No Arbitrage, Level Factor, Slope Factor
Updated on: 06/12/2018 11:09