Can Spanned Term Structure Factors Drive Stochastic Yield Volatility?


Jose A. Lopez

Glenn D. Rudebusch

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2014-03 | January 1, 2014

The ability of the usual factors from empirical arbitrage-free representations of the term structure — that is, spanned factors — to account for interest rate volatility dynamics has been much debated. We examine this issue with a comprehensive set of new arbitrage-free term structure specifications that allow for spanned stochastic volatility to be linked to one or more of the yield curve factors. Using U.S. Treasury yields, we find that much realized stochastic volatility cannot be associated with spanned term structure factors. However, a simulation study reveals that the usual realized volatility metric is misleading when yields contain plausible measurement noise. We argue that other metrics should be used to validate stochastic volatility models

Article Citation

Rudebusch, Glenn D., Jens H. E. Christensen, and Jose A. Lopez. 2014. “Can Spanned Term Structure Factors Drive Stochastic Yield Volatility?,” Federal Reserve Bank of San Francisco Working Paper 2014-03. Available at

About the Author
Jens Christensen
Jens Christensen is a research advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco. Learn more about Jens Christensen