A Regime Switching Macro-finance Model of the Term Structure

Xiaoneng Zhu and Shahidur Rahman
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Xiaoneng Zhu: Division of Economics,School of Humanities and Social Sciences, Nanyang Technological University, Singapore
Shahidur Rahman: Nanyang Technological University, Singapore

No 901, Economic Growth Centre Working Paper Series from Nanyang Technological University, School of Social Sciences, Economic Growth Centre

Abstract: This paper presents and estimates a regime switching macro-finance model of the term structure with latent and macroeconomic factors. The joint dynamics of the yield and macro factors are examined simultaneously. Both the canonical yields-only model and the macro-finance model capture two regimes in the state equation that relate to a turbulent period and a tranquil period. Statistically, the formal tests indicate signi?cant bidirectional linkages between the yield curve and economic activity. I also examine how the yield factors respond to shocks to the macro factors and the feedback of the macro factors to the yield curve. Finally, I find that the theoretical level implied by the expectations hypothesis is a good approximation of the actual level factor in the regime-shifting macro-fi?nance model framework.

Pages: 35 pages
Date: 2009-01
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