Time-varying risk premia in emerging markets: Explanation by a multi-factor affine term structure model

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From the empirical viewpoint, the Expectation Hypothesis Theory (EHT) of the term structure of interest rates has been extensively tested and rejected for US term structure data. Dai and Singleton [6] show that under the settings of Affine term structure models it is possible that one matches both the historical term structure dynamics and capture an important stylized fact that have contradicted the EHT: Time-varying risk premia. In emerging markets, economic conditions tend to be much less stable than in developed markets. For this reason, if risk premia is dynamic in such markets, intuition would suggest that it is more volatile than in developed markets, implying a stronger statistical rejection of the EHT. In this paper, we verify the robustness of Dai and Singleton's results under these more extreme market conditions. We estimate an arbitrage free Affine Gaussian model for the term structure of swaps in the Brazilian market. We propose an extensive empirical analysis which consists on: defining the optimal number of factors to be used in the model, estimating the model, giving interpretation to the state variables in terms of risk factors, and studying the model implied risk premia. In the end, we propose an application for risk management of interest rates futures portfolios.

Original languageEnglish (US)
Pages (from-to)919-947
Number of pages29
JournalInternational Journal of Theoretical and Applied Finance
Issue number7
StatePublished - Nov 2004
Externally publishedYes

All Science Journal Classification (ASJC) codes

  • General Economics, Econometrics and Finance
  • Finance


  • Affine models
  • Expectation hypothesis Theory
  • Interest rates
  • Market prices of risk
  • Risk premia


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