Drift and diffusion function specification for short-term interest rates

Various stochastic differential equation models for short rates (r_t) have been proposed, where the change (Δr_t=r_t-r_t-1) is modeled as a sum of drift and diffusion terms depending on r_t-1. These models, however, have some shortcomings. First, the same model may not apply to all countries. Second, the drift and diffusion may depend not only on r_t-1 but also on further lags. Third, not just the own lagged rates, but also other countries' rates may matter. These questions are empirically analyzed for six major countries with the following findings. First, there are considerable differences in drift and diffusion across the countries. Second, the drift and diffusion often depend on r_t-2 (and r_t-3). Third, foreign rates exert substantial effects.