We develop a class of dynamic term structure models that accommodates arbitrarily many interest-rate factors with very few parameters. The model builds on a short-rate cascade, a parsimonious recursive structure that naturally ranks the latent state variables by their rates of mean reversion, each revolving around the next lowest-frequency factor. With appropriate assumptions on volatilities and risk premia, the model overcomes the curse of dimensionality associated with general affine models. Using a panel of 15 LIBOR and swap rates, we estimate models using from one to 15 factors and only five parameters. The in-sample fit of high-dimensional specifications is near exact, with absolute pricing errors averaging less than one basis point, permitting yield-curve stripping in an arbitrage-free, dynamically consistent environment. Cross-maturity correlations accurately reflect empirical evidence, and out-of-sample interest rate forecasts significantly improve on prior benchmarks.
Bio:
Adlai J. Fisher is the A. E. Hall Chair in Finance and Associate Professor at the Sauder School of Business, University of British Columbia. He holds a B.A. degree from Macalester College and M.A., M.Phil., and Ph.D. degrees in Economics from Yale University. His interests span theoretical and empirical topics in asset pricing, investments, corporate finance, and econometrics, with current research focusing on the foundations of cross-sectional and time-series properties of stock and bond returns, performance evaluation of investment strategies, and parsimonious models of the tails, persistence, and volatility of financial returns. He also has a long-standing interest in mergers and acquisitions, including extensive business experience, and is an expert in valuation. His research has received several awards including the Smith Breeden Prize at the Journal of Finance and the faculty award for research excellence at Sauder. He is currently an Associate Editor at the Review of Finance. Professor Fisher is an accomplished teacher and advisor at the undergraduate, MBA, PhD, and executive levels, including previous experience at New York University. He is the co-author, with Laurent Calvet, of the recently published monograph Multifractal Volatility: Theory, Forecasting, and Pricing