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Working Paper
Can Spanned Term Structure Factors Drive Stochastic Yield Volatility?
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 ...