Do Korean Short-Term Interest Rates Jump?

ABSTRACT This study investigates the dynamics of Korean short-term interest rates by applying both univariate diffusion and jump diffusion models to daily overnight call rate data. Continuous diffusion models often fail to capture the sudden, discontinuous movements observed in financial data, a limitation addressed here by extending the Vasicek, CIR, CKLS, and flexible GD-GV models with a jump component. The models are estimated using maximum likelihood estimation (MLE) based on accurate, non-discretised approximate transition probability density functions (ATPDFs). Our findings provide compelling evidence for the presence and significance of jumps in the Korean overnight call rate. Jump diffusion models consistently yield substantially higher log-likelihood values, demonstrating a superior fit compared to their pure diffusion counterparts. The estimated jump intensities reveal frequent discontinuous movements, with jump volatilities contributing significantly to the overall interest rate variance. Crucially, the detected jumps are directly linked to non-linear policy interventions and systemic shocks, such as the 1997 Asian Financial Crisis, the Daewoo collapse, and subsequent BOK big step rate hikes. This study underscores the critical role of the surprise element in accurately modelling Korean short-term interest rate dynamics, offering valuable insights for financial analysis and risk management.