| Summary: | 碩士 === 淡江大學 === 財務金融學系 === 87 === Longstaff and Schwartz (1992) develop a two-factor general equilibrium model of the term structure modeled by Cox, Ingersoll, and Ross (1985a). They make a simple change of variables that allows us to express contingent claim prices in terms of two intuitive and readily estimated economic variables. These factors are the short-term interest rate r and the variance of changes in the short-term interest rate. Closed-form solutions for discount bonds and options on discount bonds can be obtained. It is tractable and easy to compute.
Longstaff-Schwartz model, however, has the advantage that the second factor interest rate volatility, its dynamics, and its factor risk premium are all endogenously determined. Furthermore, using interest rate volatility is a key variable in pricing contingent claim such as bonds and interest rate derivatives. This model explicitly takes into account the stochastic nature of interest rate volatility. In estimating V, we use the well-known GARCH framework of Bollerslev(1986). This framework is an extension of the ARCH class of Engle(1982). This specification allows unexpected changes in r to be conditionally heteroskedastic through their dependence on the value of V.
Since World War II, Europe has been in the process of reshaping itself. Its people, believing that only unity can ensure strength, prosperity and peace on their continent, have slowly but surely been coming together. "Euro" on the road have brought the dream of a new Europe－a superstate rivaling the United States in power, wealth and stature－closer to reality. This article examines the suitability of the Longstaff-Schwartz two-factor model for practical use. Discussion of issues related to the implementation of the model. To assess empirical performance, the model is used to value German and U.K. government bonds and interest rate swaps.
The result indicate that estimated government bond prices' error is average 54 basis point in Germany and 32 basis point in United Kingdom. The Longstaff and Schwartz two-factor model have more explanation about non-parallel moving of the term structure. In pricing of interest rate swap, the estimated results are the same in Germany. The model price has lower sensitivity about holding period in Germany than in U.K.. Therefore, the LS model would be helpful in capturing the characteristic in the U.K. money market.
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