The Impact of Sticky Short Rate on Long Bonds

We investigate the impact of sticky short rate on the level and volatility of long term interest rates in the context of a no-arbitrage term structure model. The stickiness is modeled through a boundary condition where as... [ view full abstract ]

We investigate the impact of sticky short rate on the level and volatility of long term interest rates in the context of a no-arbitrage term structure model. The stickiness is modeled through a boundary condition where as soon as the diffusive short rate hit an arbitrary level, it assumes that constant level for a random amount of time before it diffuses again. When policy rates are persistently low, we show how much stickiness is propagated along the yield-to-maturity dimension as well as its impact on the evolution of long rates in the physical measure.