An Empirical Study of the Chinese Short-Term Interest Rate: A Comparison of the Predictive Power of Rival One-Factor Models

This paper uses the one-factor models proposed by Chan, Karolyi, Longstaff and Sanders (CKLS, 1992) to study the short-term interest rate in China. Nine stochastic models of the short-term interest rate were estimated with GMM. For the Chinese one-month inter bank loan rate, the research finds strong evidence for a mean-reverting feature in the short-term interest yield curve, but no evidence was found to indicate that the volatility is highly positively correlated with the level of interest rates. What is more, evidence was found that the CKLS model, the CIR SR model, and the Brennan-Schwartz model are correctly specified to model the Chinese short-term interest rate, so that these three models are able to adequately capture the dynamics of this interest rate. Finally, Theil’s U2 statistics and the Diebold and Mariano test were applied to explicitly evaluate the predictive power of the single factor models.