PT  - JOURNAL ARTICLE
AU  - Hideyuki Takamizawa
AU  - Isao Shoji
TI  - Approximation of Non-Linear Term Structure Models
AID  - 10.3905/jod.2001.319156
DP  - 2001 Feb 28
TA  - The Journal of Derivatives
PG  - 44--51
VI  - 8
IP  - 3
4099  - https://pm-research.com/content/8/3/44.short
4100  - https://pm-research.com/content/8/3/44.full
AB  - “Equilibrium term structure models, like those of Vasicek, or Cox, Ingersoll, and Ross (CIR), start with assumptions about the behavior of the short rate; the full term structure is then obtained by projecting the short rate process forward. To obtain closed form valuation equations, the drift of the short rate is typically assumed to be linear, but empirical evidence suggests that its behavior is actually more complex. Short rates seem to follow a driftless random walk when they are at intermediate levels, but to exhibit mean reversion when the rate becomes very low or very high. However, incorporating a non-linear drift leads to complicated estimation problems. In this article, Takamizawa and Shoji present a linearization technique that allows them to fit a model with non-linear drift more simply. They show that with U.S. interest rate data, their approach fits better in-sample and is more accurate out of sample than a linear drift CIR model.”