Multivariate Term Structure Models with Level and Heteroskedasticity Effects

The paper introduces and estimates a multivariate level-GARCH model for the long rate and the term structure spread where the conditional volatility is proportional <p> to the y’th power of the variable itself (level effects) and the conditional covariance <p> matrix evolves according to a multivariate GARCH process (heteroskedasticity effects). <p> The conditional long rate variance exhibits heteroskedasticity effects and level effects in <p> accordance with the square-root model. The conditional spread variance exhibits heteroskedasticity <p> effects but no level effects. The level-GARCH model is preferred above the <p> GARCH model and the level model. GARCH effects are more important than level effects.