Dynamically Consistent Analysis of Realized Covariations in Term Structure Models

TL;DR

This paper introduces a nonparametric, robust method for analyzing covariations in bond prices within no-arbitrage models, revealing the complexity and time-varying nature of the term structure of volatility.

Contribution

It provides a novel approach to analyze bond covariations nonparametrically, addressing the minimal assumptions needed for identifying relevant factors in the term structure.

Findings

A high number of factors are necessary to describe the term structure evolution.

The term structure of volatility varies over time.

The method is consistent with no-arbitrage conditions.

Abstract

In this article we show how to analyze the covariation of bond prices nonparametrically and robustly, staying consistent with a general no-arbitrage setting. This is, in particular, motivated by the problem of identifying the number of statistically relevant factors in the bond market under minimal conditions. We apply this method in an empirical study which suggests that a high number of factors is needed to describe the term structure evolution and that the term structure of volatility varies over time.