Exploiting the Conditional Density in Estimating the Term Structure: An Application to the Cox, Ingersoll, and Ross Model

  • Author(s): NEIL D. PEARSON, TONG‐SHENG SUN
  • Published: Apr 30, 2012
  • Pages: 1279-1304
  • DOI: 10.1111/j.1540-6261.1994.tb02454.x

ABSTRACT

We propose an empirical method that utilizes the conditional density of the state variables to estimate and test a term structure model with known price formulae, using data on both discount and coupon bonds. The method is applied to an extension of a two‐factor model due to Cox, Ingersoll, and Ross (1985; CIR). Our results show that estimates based on only bills imply unreasonably large price errors for longer maturities. We reject the original CIR model using a likelihood ratio test, and conclude that the extended CIR model also fails to provide a good description of the Treasury market.

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