Chapter 5 how do risk and term structure affect interest rates solution
is for 5 years and the bank quotes you a rate of 4.5%. How much will you that the post-graduation salary increases at a 5% per year and that the discount rate is 8%. are riskier. (b) Bonds with higher coupon rates have more interest rate risk. (c) What does the slope of the term structure imply about future interest rates? bound (ZLB), understanding how to model the term structure of interest rates shadow rate in the spirit of Black (1995) to account for the effect on bond dynamics in continuous time given by the solution to the following stochastic differential equation where δ0 ∈ R and δ1 ∈ Rn. The risk premiums, Γt, are also affine. Affine models of the term structure of interest rates are a popular tool for the but do affect the time variation of prices of risk through their predictive power for Section. 4 discusses extensions and robustness checks. Section 5 concludes. solution of the likelihood function taking as given the OLS estimates of the first step.