Time Varying Term Premium - Targeting the Slope of the Unconditional Yield Curve
Document ID: 2009-1591
Published on: 27th October 2009
Author: Nick Jessop, Aubrey Clayton, Craig Turnbull
Because the E2FBK model contains two sources of risk – the volatility of the short rate and the volatility of the ‘mean reversion’ level - it is possible to specify two separate market prices of risk, one associated with each source of uncertainty.
The iESG 6.2.3 Time Varying Term Premium (TVTP) enhancement allows us to model each market price of risk parameter varying separately as a function of time. This enhancement allows significantly greater freedom to specify the expected evolution of interest rates produced by the ESG. This note discusses how the standard TVTP calibration methodology can be extended by clients who wish to target the slope of the unconditional yield curve in addition to the expected path for short rates.
