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Regime-Switching Univariate Diffusion Models of the Short-Term Interest Rate

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  • Choi Seungmoon

    ()
    (University of Adelaide)

Abstract

This article proposes a general regime-switching univariate diffusion model to describe the dynamics of the short-term interest rate. The maximum likelihood estimates are obtained using the weekly series of U.S. three-month treasury bill rates. The estimation results reveal that there are strong evidences for the existence of high and low volatility regimes, for the time varying transition probability of the regime variable, and for the high persistence of both regimes. In both regimes, the volatility, but not the drift, is estimated accurately and plays a key role in explaining the dynamics of the interest rates. High persistence's and different volatilities of two regimes can well explain volatility clustering observed in the data. Based on the inferred probability of the process being in each regime, most of the high volatility periods correspond to some historic events. The likelihood-based test shows that misspecification can result in misleading outcomes particularly regarding the volatility and transition probabilities of the regime index.

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Bibliographic Info

Article provided by De Gruyter in its journal Studies in Nonlinear Dynamics & Econometrics.

Volume (Year): 13 (2009)
Issue (Month): 1 (March)
Pages: 1-41

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Handle: RePEc:bpj:sndecm:v:13:y:2009:i:1:n:4

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Cited by:
  1. Seungmoon Choi, 2011. "Closed-Form Likelihood Expansions for Multivariate Time-Inhomogeneous Diffusions," School of Economics Working Papers 2011-26, University of Adelaide, School of Economics.
  2. Janczura, Joanna & Weron, Rafal, 2011. "Goodness-of-fit testing for the marginal distribution of regime-switching models," MPRA Paper 32532, University Library of Munich, Germany.
  3. Stéphane Goutte & Benteng Zou, 2012. "Continuous time regime switching model applied to foreign exchange rate," Working Papers hal-00643900, HAL.
  4. Stéphane GOUTTE & Benteng Zou, 2011. "Foreign exchange rates under Markov Regime switching model," CREA Discussion Paper Series 11-16, Center for Research in Economic Analysis, University of Luxembourg.
  5. Joanna Janczura & Rafal Weron, 2012. "Inference for Markov-regime switching models of electricity spot prices," HSC Research Reports HSC/12/01, Hugo Steinhaus Center, Wroclaw University of Technology.
  6. Choi, Seungmoon, 2013. "Closed-form likelihood expansions for multivariate time-inhomogeneous diffusions," Journal of Econometrics, Elsevier, vol. 174(2), pages 45-65.
  7. Joanna Janczura & Rafał Weron, 2013. "Goodness-of-fit testing for the marginal distribution of regime-switching models with an application to electricity spot prices," AStA Advances in Statistical Analysis, Springer, vol. 97(3), pages 239-270, July.
  8. Stéphane Goutte, 2012. "Conditional Markov regime switching model applied to economic modelling," Working Papers hal-00747479, HAL.

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