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Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model
Robert F. Engle, David M. Lilien and Russell P. Robins
Vol. 55, No. 2 (Mar., 1987), pp. 391-407
Published by: The Econometric Society
Stable URL: http://www.jstor.org/stable/1913242
Page Count: 17
You can always find the topics here!Topics: Statistical variance, Economic models, Risk premiums, Risk aversion, Statistical models, Yield curves, Interest rates, Econometrics, Financial economics, Economic expectations
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The expectation of the excess holding yield on a long bond is postulated to depend upon its conditional variance. Engle's (1982a) ARCH model is extended to allow the conditional variance to be a determinant of the mean and is called ARCH-M. Estimation and inference procedures are proposed and the model is applied to three interest rate data sets. In most cases the ARCH process and the time varying risk premium are highly significant. A collection of LM diagnostic tests reveals the robustness of the model to various specification changes such as alternative volatility or ARCH measures, regime changes, and interest rate formulations. The model explains and interprets the recent econometric failures of the expectations hypothesis of the term structure.
Econometrica © 1987 The Econometric Society