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Is the Short Rate Drift Actually Nonlinear?

David A. Chapman and Neil D. Pearson
The Journal of Finance
Vol. 55, No. 1 (Feb., 2000), pp. 355-388
Published by: Wiley for the American Finance Association
Stable URL: http://www.jstor.org/stable/222558
Page Count: 34
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Is the Short Rate Drift Actually Nonlinear?
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Abstract

Aït-Sahalia (1996) and Stanton (1997) use nonparametric estimators applied to short-term interest rate data to conclude that the drift function contains important nonlinearities. We study the finite-sample properties of their estimators by applying them to simulated sample paths of a square-root diffusion. Although the drift function is linear, both estimators suggest nonlinearities of the type and magnitude reported in Aït-Sahalia (1996) and Stanton (1997). Combined with the results of a weighted least squares estimator, this evidence implies that nonlinearity of the short rate drift is not a robust stylized fact.

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