Term structure of interest rates with regime shifts

Ravi Bansal and Hao Zhou

No 2001-46, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We develop a term structure model where the short interest rate and the market price of risks are subject to discrete regime shifts. Empirical evidence from Efficient Method of Moments estimation provides considerable support for the regime shifts model. Standard models, which include affine specifications with up to three factors, are sharply rejected in the data. Our diagnostics show that only the regime shifts model can account for the well documented violations of the expectations hypothesis, the observed conditional volatility, and the conditional correlation across yields. We find that regimes are intimately related to business cycles.

Keywords: Interest rates; Monetary policy; Econometric models (search for similar items in EconPapers)
Date: 2001
New Economics Papers: this item is included in nep-pke
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