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Affine arbitrage-free yield net models with application to the euro debt crisis

Author

Listed:
  • Zhiwu Hong
  • Linlin Niu
  • Chen Zhang
Abstract
We develop a parsimonious class of affine arbitrage-free yield net models for consistent bond pricing across maturities and issuers of different risk levels. Containing a core curve and multiple peripheral curves, the yield net is spanned by three layers of factors: base factors spanning all curves, and common and individual spread factors. Under the arbitrage-free assumption, we prove a parsimonious solution to the risk-neutral process that guarantees joint identification of parameters and latent states. By using a Bayesian estimation method with a marginal Metropolis-Hastings algorithm and specification tests based on MCMC output, we apply the model to weekly treasury yields of Germany, Italy, Spain, and Greece from 2009 to 2016. The results show that the extracted common credit risk is a level factor in spread, and market liquidity risk is a slope factor. Further, the net structure helps reconstruct the Greek yield curve even with only its 10-year yield available throughout the sample.

Suggested Citation

  • Zhiwu Hong & Linlin Niu & Chen Zhang, 2019. "Affine arbitrage-free yield net models with application to the euro debt crisis," Working Papers 2019-01-30, Wang Yanan Institute for Studies in Economics (WISE), Xiamen University, revised 06 Nov 2021.
    • Handle: RePEc:wyi:wpaper:002392
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    References listed on IDEAS

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    Cited by:

    1. Lin, Mucai & Hong, Zhiwu & Su, Ge, 2024. "Transmission of liquidity and credit risks in the Chinese bond market: Analysis based on joint modeling of multiple yield curves," International Review of Economics & Finance, Elsevier, vol. 91(C), pages 597-615.
    2. Zhuang, Yangyang & Zhang, Ditian & Tang, Pan & Peng, Hongjuan, 2024. "Clustering effects and evolution of the global major 10-year government bond market structure: A network perspective," The North American Journal of Economics and Finance, Elsevier, vol. 70(C).

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    More about this item

    Keywords

    Term structure models; European debt crisis; liquidity; sovereign credit risk; Nelson-Siegel factors;
    All these keywords.

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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