Specification analysis of affine term structure models

This paper explores the structural differences and relative goodness-of-fits of affine term structure models (ATSMs). Within the family of ATSMs there is a tradeoff between flexibility in modeling the conditional correlations and volatilities of the risk factors. This trade-off is formalized by our classification of N-factor affine family into N + 1 non-nested subfamilies of models. Specializing to three-factor ATSMs, our analysis suggests, based on theoretical considerations and empirical evidence, that some subfamilies of ATSMs are butter suited than others to explaining historical interest rate behavior.