Real-world interest calibration: Comparing the constant and time-varying risk premium model calibration
Document ID: 2009-1529 (previously 2009/11)
Published on: 4th September 2009
Author: Jack Cheyne, Zhuoshi Liu & Steffen Sorensen
The extended 2 FBK model will be available with both a constant and a time-varying market price of risk in iESG version 6.2.3. While we have provided calibrations of the constant market price of risk model (the constant term premium model, CTP) in the past, we will provide a calibration of the time-varying market price of risk model (the time-varying term premium model, TVTP) from end September 2009.
This note compares the CTP and TVTP model calibrations for USD, GBP, EUR, JPY and ZAR. We show that the CTP model calibration is consistent with a view that excess returns on a government bond are broadly constant through time while the expected short rate is almost perfectly correlated with the initial forward curve. Using the TVTP model calibration, and our methodology for setting a target path for the nominal short rate, leads to a stable mean reverting nominal short rate while the excess return on government bonds varies through time (with term).
