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| Author: | Collin-Dufresne, P. Goldstein, R. |
| Title: | Do bonds span the fixed income markets? Theory and evidence for unspanned stochastic volatility |
| Journal: | Journal of Finance
2002 : AUG, VOL. 57:4, p. 1685-1730 |
| Index terms: | Financial theory Bonds Incomes Stochastic processes Volatility |
| Language: | eng |
| Abstract: | Most term structure models assume bond ,markets are complete, but is, that all fixed income derivatives can be perfectly replicated using solely bonds. However, the authors find that, in practice, swap rates have limited explanatory power for returns on at-the-money straddles - portfolios mainly exposed to volatility risk. They term this empirical feature "unspanned stochastic volatility". While USV can be captured within an HJM framework, the authors demonstrate that bivariate models cannot exhibit USV. They determine necessary and sufficient conditions for trivariate Markov affine systems to exhibit USV. For such USV models, bonds alone may not be sufficient to identify all parameters. |
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