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

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Author Info
Yong Zeng
Shu Wu
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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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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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates

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