Markov-Switching and Stochastic Volatility Diffusion Models of Short-Term Interest Rates

Daniel Smith ()

Journal of Business & Economic Statistics, 2002, vol. 20, issue 2, 183-97

Abstract: This article empirically compares the Markov-switching and stochastic volatility diffusion models of the short rate. The evidence supports the Markov-switching diffusion model. Estimates of the elasticity of volatility parameter for single-regime models unanimously indicate an explosive volatility process, whereas the Markov-switching models estimates are reasonable. It is found that either Markov switching or stochastic volatility, but not both, is needed to adequately fit the data. A robust conclusion is that volatility depends on the level of the short rate. Finally, the Markov-switching model is the best for forecasting. A technical contribution of this article is a presentation of quasi-maximum likelihood estimation techniques for the Markov-switching stochastic-volatility model.

Date: 2002
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Persistent link: https://EconPapers.repec.org/RePEc:bes:jnlbes:v:20:y:2002:i:2:p:183-97

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