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A General Equilibrium Model Of The Term Structure Of Interest Rates Under Regime-Switching Risk

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  • SHU WU

    ()
    (Department of Economics at The University of Kansas, Summerfield Hall 213, Lawrence, KS 66045, USA)

  • YONG ZENG

    ()
    (Department of Mathematics and Statistics at University of Missouri at Kansas City, Kansas City, MO 64110, USA)

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Abstract

This paper develops a general equilibrium model of the term structure of interest rates in the presence of the systematic risk of regime shifts. The model elucidates the economic nature of the regime-shift risk premium and introduces a new source of time-variation in bond returns. A closed-form solution for the term structure of interest rates is obtained under an affine model using log-linear approximation. The model is estimated by Efficient Method of Moments. The regime-switching risk is found to be statistically significant and mostly affect the long-end of the yield curve.

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Bibliographic Info

Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

Volume (Year): 08 (2005)
Issue (Month): 07 ()
Pages: 839-869

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Handle: RePEc:wsi:ijtafx:v:08:y:2005:i:07:p:839-869

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Keywords: Term structure; general equilibrium; Markov regime shifts;

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  1. Bansal, Ravi & Gallant, A. Ronald & Hussey, Robert & Tauchen, George, 1995. "Nonparametric estimation of structural models for high-frequency currency market data," Journal of Econometrics, Elsevier, vol. 66(1-2), pages 251-287.
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  14. Jacob Boudoukh & Matthew Richardson & Tom Smith & Robert Whitelaw, 1999. "Regime Shifts and Bond Returns," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-010, New York University, Leonard N. Stern School of Business-.
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Cited by:
  1. Hidenori Futami, 2009. "Multi-factor Affine Term Structure Model with Single Regime Shift: Real Term Structure under Zero Interest Rate," Asia-Pacific Financial Markets, Springer, vol. 16(4), pages 347-369, December.
  2. John Driffill & Turalay Kenc & Martin Sola, 2013. "Real Options With Priced Regime-Switching Risk," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(05), pages 1350028-1-1.
  3. Shu Wu & Yong Zeng, 2005. "The Term Structure of Interest Rates under Regime Shifts and Jumps," WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS 200520, University of Kansas, Department of Economics, revised Oct 2005.
  4. Hoi Wong & Tsz Wong, 2007. "Reduced-form Models with Regime Switching: An Empirical Analysis for Corporate Bonds," Asia-Pacific Financial Markets, Springer, vol. 14(3), pages 229-253, September.
  5. Monfort, A. & Pegoraro, F., 2007. "Switching VARMA Term Structure Models - Extended Version," Working papers 191, Banque de France.

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