| Abstract: | Using a new Bayesian method for the analysis of diffusion processes,this article finds that the nonlinear drift in interest ratesfound in a number of previous studies can be confirmed onlyunder prior distributions that are best described as informative.The assumption of stationarity, which is common in the literature,represents a nontrivial prior belief about the shape of thedrift function. This belief and the use of "flat" priors contributestrongly to the finding of nonlinear mean reversion. Implementationof an approximate Jeffreys prior results in virtually no evidencefor mean reversion in interest rates unless stationarity isassumed. Finally, the article documents that nonlinear driftis primarily a feature of daily rather than monthly data, andthat these data contain a transitory element that is not reflectedin the volatility of longer-maturity yields. |
