Premium
Term Structure of Interest Rates with Regime Shifts
Author(s) -
Bansal Ravi,
Zhou Hao
Publication year - 2002
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/0022-1082.00487
Subject(s) - econometrics , volatility (finance) , economics , affine term structure model , affine transformation , interest rate , term (time) , yield curve , conditional expectation , mathematics , physics , monetary economics , quantum mechanics , pure mathematics
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.