A comparative evaluation of alternative models of the term structure of interest rates

In the paper alternative models of the term structure of interest rates are classified in two different approaches: the no-arbitrage and the general equilibrium approach. It is maintained that the general equilibrium approach is superior on a theoretical ground for two main reasons: first, relevant variables, such as the spot interest rate and the interest risk-premium, are endogenous; second, the relationship between the real and the financial side of the economy becomes a clear and important element in the understanding of the term structure. As regards the applications, however, the advantages of the general equilibrium over the no-arbitrage approach are not so clear: the major role in the empirical performance of alternative models is played by their ability to capture volatility. At the current state of the literature, there is no model that outperforms others, in particular on the empirical side.