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Flexible Threshold Models for Modelling Interest Rate Volatility

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  • Petros Dellaportas
  • David G. T. Denison
  • Chris Holmes
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    Abstract

    This paper focuses on interest rate models with regime switching and extends previous nonlinear threshold models by relaxing the assumption of a fixed number of regimes. Instead we suggest automatic model determination through Bayesian inference via the reversible jump Markov Chain Monte Carlo (MCMC) algorithm. Moreover, we allow the thresholds in the volatility to be driven not only by the interest rate but also by other economic factors. We illustrate our methodology by applying it to interest rates and other economic factors of the American economy.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/07474930701220600
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Econometric Reviews.

    Volume (Year): 26 (2007)
    Issue (Month): 2-4 ()
    Pages: 419-437

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    Handle: RePEc:taf:emetrv:v:26:y:2007:i:2-4:p:419-437

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    Related research

    Keywords: Interest rates; Markov Chain Monte Carlo; Reversible jump; Threshold model;

    References

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    1. Gary M. Koop & Simon M. Potter, 2004. "Forecasting and estimating multiple change-point models with an unknown number of change points," Staff Reports 196, Federal Reserve Bank of New York.
    2. Michael Dueker, 1995. "Markov switching in GARCH processes and mean reverting stock market volatility," Working Papers 1994-015, Federal Reserve Bank of St. Louis.
    3. Pfann, Gerard A. & Schotman, Peter C. & Tschernig, Rolf, 1996. "Nonlinear interest rate dynamics and implications for the term structure," Journal of Econometrics, Elsevier, vol. 74(1), pages 149-176, September.
    4. Ching-Fan Chung & Mao-Wei Hung, 2000. "A general model for short-term interest rates," Applied Economics, Taylor & Francis Journals, vol. 32(2), pages 111-121.
    5. Gary Koop & Simon M. Potter, 2004. "Dynamic asymmetries in US unemployment," ESE Discussion Papers 15, Edinburgh School of Economics, University of Edinburgh.
    6. repec:fth:louvco:0038 is not listed on IDEAS
    7. Brenner, Robin J. & Harjes, Richard H. & Kroner, Kenneth F., 1996. "Another Look at Models of the Short-Term Interest Rate," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(01), pages 85-107, March.
    8. LUBRANO, Michel, 2000. "Bayesian non-linear modellings of the short term US interest rate: the help of non-parametric tools," CORE Discussion Papers 2000038, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    9. Gary M. Koop & Simon M. Potter, 2004. "Prior elicitation in multiple change-point models," Staff Reports 197, Federal Reserve Bank of New York.
    10. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
    11. Lamoureux, Christopher G & Lastrapes, William D, 1990. "Persistence in Variance, Structural Change, and the GARCH Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(2), pages 225-34, April.
    12. Hamilton, James D., 1988. "Rational-expectations econometric analysis of changes in regime : An investigation of the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 385-423.
    13. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
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