GMM Estimation For Single-factor Term Structure Of Interest Rate Models And The Empirical Test Of Chinese Money Market

As one of the most important price variables in the financial markets, among which the short-term interest rates are crucial to the pricing of fixed income securities and their derivatives, interest rates are always the highlight of financial research. The term structure of interest rates describes the relationships between the yields of zero coupon bonds and their terms to maturity. In case of single-factor interest rate models, there is only one state variable, the default-free instantaneous interest rate. The instantaneous interest rate dynamics determines the whole term structure of interest rate. Unfortunately, the instantaneous interest rate does not exist in real world, so we must use short-term interest rates as its proxy.Merton pioneered to model interest rates dynamics by stochastic differential equations. Since then, many researchers had proposed various kinds of stochastic differential equations to describe interest rates movements. This article does empirical analysis for Chinese money market, trying to exploring below questions: The drift is linear or nonlinear? The mean-reverting effect of interest rate is significant or not? The sensitivity of interest rate volatility to interest rate level is high or not?This article analyses interbank offer market and bond repo market in China and interest rates liberalization process in this market, then points out the achievement and the existing drawback. There are so many kinds of interest rates in the market, for example, there are fourteen short term interest rates whose terms to maturity are below three month. According to the correlation principle and selecting the most frequently traded, largest traded volume item, this article finds that R007 is the best proxy for instantaneous interest rate.It is the key of the term structure of interest rates to build models for instantaneous interest rate as to price interest rate derivatives easily and reasonably and hedge interest rate risk. The highlight of this article is that based on several famous interest rate models, a new general model is proposed whose drift can be linear and nonlinear. I estimate the parameters of different models by GMM, and obtain a better model under comparison by many indexes. This model has nonlinear drift, has significant mean-reverting effect, and the volatility is highly sensitive to interest level.