A parametric nonlinear model of term structure dynamics

Recent nonparametric estimation studies pioneered by Ait-Sahalia document t hat the diffusion of the short rate is similar to the parametric function, r(1.5), estimated by Chan et al., whereas the drift is substantially nonlin ear in the short rate. These empirical properties call into question the ef ficacy of the existing affine term structure models and beg for alternative models which admit the observed behavior. This article presents such a mod el, Our model delivers closed-form solutions for bond prices and a concave relationship between the interest rate and the yields, We show that in empi rical analyses, our model outperforms the one-factor affine models in both time-series as well as cross-sectional tests.