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

ABSTRACT

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.

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