A regime-switching term structure model with observable state variables

René Ferland, Geneviève Gauthier and Simon Lalancette

Finance Research Letters, 2010, vol. 7, issue 2, 103-109

Abstract: The paper proposes in a regime-shift framework, an arbitrage-free term structure model based on the target and Fed Funds Rates. Empirical observations suggest that a three-state regime-shift environment associated with FOMC monetary actions is justified. Then, a closed-form solution for zero-coupon bonds is derived where regime-shift risk is priced. The solution is flexible enough to incorporate additional state variables.

Keywords: C02; E43; G10; G12; Regime-switch; Target; rate; Risk-neutral; valuation; Markov; chains (search for similar items in EconPapers)
Date: 2010
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:7:y:2010:i:2:p:103-109

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