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A General Equilibrium Model of the Term Structure of Interest Rates under Regime-switching Risk

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  • Yong Zeng
  • Shu Wu
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Abstract

This paper incorporates the systematic risk of regime shifts into a general equilibrium model of the term structure of interest rates. The model shows that there is a new source of time-variation in bond term premiums in the presence of regime shifts. This new component is a regime-switching risk premium that depends on the covariations between discreet changes in marginal utility and bond prices across different regimes. 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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File URL: http://repec.org/esNASM04/up.24288.1075421015.pdf
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Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 304.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:304

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Keywords: The Term Structure; General Equilibrium; Markov Regime Shifts;

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  9. Gray, Stephen F., 1996. "Modeling the conditional distribution of interest rates as a regime-switching process," Journal of Financial Economics, Elsevier, Elsevier, vol. 42(1), pages 27-62, September.
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  14. Ang, Andrew & Bekaert, Geert, 2002. "Regime Switches in Interest Rates," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 20(2), pages 163-82, April.
  15. Filardo, Andrew J, 1994. "Business-Cycle Phases and Their Transitional Dynamics," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 12(3), pages 299-308, July.
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Cited by:
  1. Hoi Wong & Tsz Wong, 2007. "Reduced-form Models with Regime Switching: An Empirical Analysis for Corporate Bonds," Asia-Pacific Financial Markets, Springer, Springer, vol. 14(3), pages 229-253, September.
  2. Wu, Shu & Zeng, Yong, 2006. "The term structure of interest rates under regime shifts and jumps," Economics Letters, Elsevier, Elsevier, vol. 93(2), pages 215-221, November.
  3. 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., World Scientific Publishing Co. Pte. Ltd., vol. 16(05), pages 1350028-1-1.
  4. Monfort, A. & Pegoraro, F., 2007. "Switching VARMA Term Structure Models - Extended Version," Working papers, Banque de France 191, Banque de France.
  5. 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, Springer, vol. 16(4), pages 347-369, December.

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