THE INFORMATION-CONTENT IN BOND MODEL RESIDUALS - AN EMPIRICAL-STUDY ON THE BELGIAN BOND MARKET

We estimate daily Vasicek, CIR, and spline models on Belgian data and compare the trading profits that can be made on the basis of their res iduals. Abnormal returns, measured using three different benchmarks, a re negatively related to once- and twice-lagged mispricing, Buying und erpriced bonds and (especially) selling overpriced bonds yields signif icant abnormal returns even when the trade is delayed by up to five da ys after observing the mispricing. The traditional spline model overfi ts the data and is least able to detect mispricing. Large model residu als are more likely to be the result of model misspecification or -est imation than are small or medium-sized residuals. (C) 1997 Elsevier Sc ience B.V.