Markov Switching Risk Premium and the term structure of interest rates. Empirical evidence from US post-war interest rates

María José Gutiérrez Huerta and Jesús Vázquez Pérez

No 1988-088X, DFAEII Working Papers from University of the Basque Country - Department of Foundations of Economic Analysis II

Abstract: This paper considers the basic present value model of interest rates under rational expectations with two additional features. First, following McCallum (1994), the model assumes a policy reaction function where changes in the short-term interest rate are determined by the long-short spread. Second, the short-term interest rate and the risk premium processes are characterized by a Markov regime-switching model. Using US post-war interest rate data, this paper finds evidence that a two-regime switching model fits the data better than the basic model. The estimation results also show the presence of two alternative states displaying quite different features.

Keywords: term-structure; risk premium; Markov regime-switching (search for similar items in EconPapers)
Date: 2002-04
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Dpto. de Fundamentos del Análisis Económico II, = Facultad de CC. Económicas y Empresariales, Universidad del País Vasco, Avda. Lehendakari Aguirre 83, 48015 Bilbao, Spain

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