Testing affine term structure models in case of transaction costs |
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| Institution: | 1. Finance Group, Faculty of Economics and Econometrics, University of Amsterdam, Roetersstraat 11, 1018 WB Amsterdam, The Netherlands;2. Department of Econometrics and Department of Finance, Faculty of Economics, Tilburg University, PO Box 90153, 5000 LE, Tilburg, The Netherlands;1. Department of Chemistry, University College for Women, Ain Shams University, 11566 Cairo, Egypt;2. Department of Chemistry, Faculty of Science, Ain Shams University, 11566 Cairo, Egypt;1. College of Textile Engineering, Zhejiang Industry Polytechnic College, Shaoxing 312000, PR China;2. College of Science, Tianjin University of Science & Technology, Tianjin 300457, PR China;3. College of Environment and Chemical Engineering & State Key Laboratory of Hollow-Fiber Membrane Materials and Membrane Processes, Tianjin Polytechnic University, Tianjin 300387, PR China;4. Institute of Composite Materials & Ministry of Education Key Laboratory of Advanced Textile Composite Materials, Tianjin Polytechnic University, Tianjin 300387, PR China |
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| Abstract: | We empirically analyze the impact of transaction costs on the performance of essentially affine interest rate models. We test the implied Euler restrictions and calculate the specification error bound of Hansen and Jagannathan to measure model misspecification. Using both short-maturity and long-maturity bond return data we find, under the assumption of frictionless markets, strong evidence of misspecification of affine yield models with up to three factors. Next, we incorporate transaction costs in our tests. The results show that the evidence of misspecification of essentially affine yield models disappears in case of monthly holding periods at market size transaction costs. |
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