Faculty of Economics and Business Administration Publications Database

Pricing the term structure with linear regressions

Adrian, Tobias
Crump, Richard K.
Volume: 110
Number: 1
Pages: 110 - 138
Month: October
ISSN-Print: 0304-405X
Link External Source: Online Version
Year: 2013
Keywords: Term structure of interest rates; Fama-MacBeth regressions; Dynamic asset pricing estimation; Empirical finance

We show how to price the time series and cross section of the term structure of interest rates using a three-step linear regression approach. Our method allows computationally fast estimation of term structure models with a large number of pricing factors. We present specification tests favoring a model using five principal components of yields as factors. We demonstrate that this model outperforms the Cochrane and Piazzesi (2008) four-factor specification in out-of-sample exercises but generates similar in-sample term premium dynamics. Our regression approach can also incorporate unspanned factors and allows estimation of term structure models without observing a zero-coupon yield curve.