The Statistical and Economic Role of Jumps in Continuous‐Time Interest Rate Models
- Author(s): Michael Johannes
- Published: Nov 27, 2005
- Pages: 227-260
- DOI: 10.1111/j.1540-6321.2004.00632.x
This paper analyzes the role of jumps in continuous‐time short rate models. I first develop a test to detect jump‐induced misspecification and, using Treasury bill rates, find evidence for the presence of jumps. Second, I specify and estimate a nonparametric jump‐diffusion model. Results indicate that jumps play an important statistical role. Estimates of jump times and sizes indicate that unexpected news about the macroeconomy generates the jumps. Finally, I investigate the pricing implications of jumps. Jumps generally have a minor impact on yields, but they are important for pricing interest rate options.