An empirical implementation of a non-parametric estimation approach for a two-factor term structure model

Knight, Li, and Yuan (1999) have developed a non-parametric procedure for e stimating diffusion functions in a general multivariate diffusion process. We apply this estimation procedure to a two-factor term structure model. Fu rthermore, under this two-factor term structure model, we propose and perfo rm a numerical procedure, the Monte Carlo simulation procedure, to value in terest rate derivative securities. The results are compared with those calc ulated under an alternative parametric model and show significant differenc es.