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There is evidence that jumps double the explanation power of Campbell and Shiller (1991) excess bond returns regressions (Wright and Zhou (2009)), and options bring information about bond risk premia beyond that spanned by the yield curve (Joslin (2007)). In this paper I incorporate these features in a Gaussian Affine Term Structure Model (ATSM) in order to assess two questions: (1) what are the implications of incorporating jumps in an ATSM for option pricing, and (2) how jumps and options affect the bond risk-premia dynamics.
The main findings are: (1) jump risk-premia is negative in a scenario of decreasing interest rates and explain 10%-20% of the level of yields, (2) options help to reconcile, in part, the weak form of Expectation Hypothesis, and (3) gaussian models without jumps and with constant intensity jumps are good to price options.