Journal of banking & finance vol:21 issue:5 pages:685-720
We estimate daily Vasicek, CIR, and spline models on Belgian data and compare the trading profits that can be made on the basis of their residuals. Abnormal returns, measured using three different benchmarks, are negatively related to once- and twice-lagged mispricing, Buying underpriced bonds and (especially) selling overpriced bonds yields significant abnormal returns even when the trade is delayed by up to five days after observing the mispricing. The traditional spline model overfits the data and is least able to detect mispricing. Large model residuals are more likely to be the result of model misspecification or -estimation than are small or medium-sized residuals. (C) 1997 Elsevier Science B.V.