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The Term Structure of Interest Rates under Regime Shifts and Jumps

Author

Listed:
  • Shu Wu

    (Department of Economics, The University of Kansas)

  • Yong Zeng

Abstract

This paper develops a tractable dynamic term structure models under jump-diffusion and regime shifts with time varying transition probabilities. The model allows for regime-dependent jumps while both jump risk and regime-switching risk are priced. Closed form solution for the term structure is obtained for an affine-type model under loglinear approximation.

Suggested Citation

  • 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.
    • Handle: RePEc:kan:wpaper:200520
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    File URL: http://www.ku.edu/~bgju/2005Papers/200520.pdf
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    References listed on IDEAS

    as
    1. Das, Sanjiv R., 2002. "The surprise element: jumps in interest rates," Journal of Econometrics, Elsevier, vol. 106(1), pages 27-65, January.
    2. Camilla LandÊn, 2000. "Bond pricing in a hidden Markov model of the short rate," Finance and Stochastics, Springer, vol. 4(4), pages 371-389.
    3. Monika Piazzesi, 2005. "Bond Yields and the Federal Reserve," Journal of Political Economy, University of Chicago Press, vol. 113(2), pages 311-344, April.
    4. Qiang Dai & Kenneth J. Singleton, 2000. "Specification Analysis of Affine Term Structure Models," Journal of Finance, American Finance Association, vol. 55(5), pages 1943-1978, October.
    5. Ahn, Chang Mo & Thompson, Howard E, 1988. " Jump-Diffusion Processes and the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 43(1), pages 155-174, March.
    6. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, February.
    7. Ravi Bansal & Hao Zhou, 2002. "Term Structure of Interest Rates with Regime Shifts," Journal of Finance, American Finance Association, vol. 57(5), pages 1997-2043, October.
    8. Shu Wu & Yong Zeng, 2005. "A General Equilibrium Model Of The Term Structure Of Interest Rates Under Regime-Switching Risk," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 8(07), pages 839-869.
    9. Darrell Duffie & Rui Kan, 1996. "A Yield‐Factor Model Of Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(4), pages 379-406, October.
    10. Darrell Duffie & Jun Pan & Kenneth Singleton, 2000. "Transform Analysis and Asset Pricing for Affine Jump-Diffusions," Econometrica, Econometric Society, vol. 68(6), pages 1343-1376, November.
    11. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
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    Citations

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    Cited by:

    1. Ferland, René & Gauthier, Geneviève & Lalancette, Simon, 2010. "A regime-switching term structure model with observable state variables," Finance Research Letters, Elsevier, vol. 7(2), pages 103-109, June.
    2. Hunt, Julien & Devolder, Pierre, 2011. "Semi-Markov regime switching interest rate models and minimal entropy measure," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 390(21), pages 3767-3781.
    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., vol. 16(05), pages 1-30.
    4. Tomás Caravello & Turalay Kenc & Martín Sola, 2021. "Risk Aversion and Changes in Regime," Department of Economics Working Papers 2021_08, Universidad Torcuato Di Tella.
    5. Liu Xiangdong & Li Xianglong & Zheng Shaozhi & Qian Hangyong, 2020. "PMCMC for Term Structure of Interest Rates under Markov Regime Switching and Jumps," Journal of Systems Science and Information, De Gruyter, vol. 8(2), pages 159-169, April.
    6. Samuel Chege Maina, 2011. "Credit Risk Modelling in Markovian HJM Term Structure Class of Models with Stochastic Volatility," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 1-2011.
    7. López, Oscar & Oleaga, Gerardo & Sánchez, Alejandra, 2021. "Markov-modulated jump-diffusion models for the short rate: Pricing of zero coupon bonds and convexity adjustment," Applied Mathematics and Computation, Elsevier, vol. 395(C).
    8. El-khatib, Youssef & Hatemi-J, Abdulnasser, 2013. "On option pricing in illiquid markets with random jumps," MPRA Paper 45172, University Library of Munich, Germany.
    9. Samuel Chege Maina, 2011. "Credit Risk Modelling in Markovian HJM Term Structure Class of Models with Stochastic Volatility," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 5, July-Dece.

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    More about this item

    Keywords

    Term Structure; Regime Switching; Jump Diffusion; Marked Point Process;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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