International Journal of Business and Social Science

ISSN 2219-1933 (Print), 2219-6021 (Online) DOI: 10.30845/ijbss

Estimation of one- and two-factor Vasicek term structure model of interest rates for the West African Economic and Monetary Union countries

Term structure of interest rates has played an important role in the pricing of fixed-income securities. In this paper, we compare a one-factor with a two-factor Vasicek model of the term structure of interests. It is assumed that default-free discount bonds are determined by two factors that follow a joint Ornstein-Uhlenbeck process: the foreign interest rate and the spread between the domestic, proxied by the 7-day weighted interbank rate and foreign interest rates, represented by the Euribor 3-month rate. Assuming that the domestic interest rate is the sum of the spread and the foreign interest rate, a domestic bond pricing equation is derived and term structure interest rate is obtained. Empirical evidence of the model’s performance in comparison with a one-factor Vasicek model is presented. The results show that the two-factor Vasicek does not perform better than the one-factor Vasicek model in predicting future movements of domestic interest rates.

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