The affine dynamic term structure model (DTSM) is the canonical empirical finance representation of the yield curve. However, the possibility that DTSM estimates may be distorted by small-sample bias has been largely ignored. We show that conventional estimates of DTSM coefficients are indeed severely biased, and this bias results in misleading estimates of expected future short-term interest rates and of long-maturity term premia. We provide a variety of bias-corrected estimates of affine DTSMs, both for maximally-flexible and over-identified specifications. Our estimates imply short rate expectations and term premia that are more plausible from a macro-finance perspective.
Rudebusch, Glenn D., Jing (Cynthia) Wu, and Michael Bauer. 2011. “Correcting Estimation Bias in Dynamic Term Structure Models,” Federal Reserve Bank of San Francisco Working Paper 2011-12. Available at https://doi.org/10.24148/wp2011-12