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Rev Fin 2004; 17:379-404
The Review of Financial Studies Vol. 17, No. 2, pp. 379–404 © 2004 The Society for Financial Studies; all rights reserved.

Evaluating an Alternative Risk Preference in Affine Term Structure Models

Jefferson Duarte
University of Washington and IBMEC

Address correspondence to Jefferson Duarte, University of Washington Business School, 267 MacKenzie Hall, Box 353200, Seattle, WA 98195-3200, or e-mail: jduarte{at}u.washington.edu.

Dai and Singleton (2002) and Duffee (2002) show that there is a tension in affine term structure models between matching the mean and the volatility of interest rates. This article examines whether this tension can be solved by an alternative parametrization of the price of risk. The empirical evidence suggests that, first, the examined parametrization is not sufficient to solve the mean-volatility tension. Second, the usual result in the estimation of affine models, indicating that some of the state variables are extremely persistent, may have been caused by the lack of flexibility in the parametrization of the price of risk.


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