Sample path equilibrium: an explicit multifactor restriction and simulation studies

Abstract

The sample path equilibrium model (Feldman (2002)) under incomplete infor- mation economy sets up a functional relation between equilibrium spot rates of interest and observable realized security returns. In this thesis, we extend the sample path equilibrium explicit one factor restriction to a multifactor one. We simulate the instantaneous interest rate under the incomplete infor- mation equilibrium and calculate the forecasted spot rate predicted by the sample path equilibrium model. Accounting for discretization of the data and firm bankruptcies, we confirm that the sample path equilibrium model holds with small measurement errors. Based on the simulation results, we further conduct sensitivity analysis of the error terms arising from each realization, thus laying a foundation for future empirical implementation.