TRACTABLE AFFINE VOLATILITY TERM STRUCTURE MODELS

Abstract

In affine term structure models the drift and conditional variance of the factors driving the short interest rate are affine in the factors themselves. This paper provides bond prices in approximate closed form when the drift and the conditional standard deviation (i.e. volatility, not variance) of the said factors are affine in the factors themselves, so as to bypass the admissibility and tractability restrictions of affine models. However the empirical evidence from US yields shows that "affine volatility" models do not fit yields and yield volatilities better than affine models. Thus the admissibility and tractability restrictions of affine models do not "cost much".