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Threshold Dynamics of Short‐term Interest Rates: Empirical Evidence and Implications for the Term Structure

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  • Theofanis Archontakis
  • Wolfgang Lemke

Abstract

This paper studies a nonlinear one‐factor term structure model in discrete time. The short‐term interest rate follows a self‐exciting threshold autoregressive (SETAR) process that allows for shifts in the intercept and the variance. In comparison with a linear model, we find empirical evidence in favour of the threshold model for Germany and the US. Based on the estimated short‐rate dynamics we derive the implied arbitrage‐free term structure of interest rates. Since analytical solutions are not feasible, bond prices are computed by means of Monte Carlo integration. The resulting term structure captures stylized facts of the data. In particular, it implies a nonlinear relation between long rates and the short rate.

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  • Theofanis Archontakis & Wolfgang Lemke, 2008. "Threshold Dynamics of Short‐term Interest Rates: Empirical Evidence and Implications for the Term Structure," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 37(1), pages 75-117, February.
    • Handle: RePEc:bla:ecnote:v:37:y:2008:i:1:p:75-117
    DOI: 10.1111/j.1468-0300.2008.00189.x
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    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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