IDEAS home Printed from https://ideas.repec.org/a/eee/finlet/v7y2010i2p103-109.html

A regime-switching term structure model with observable state variables

Author

Listed:
  • Ferland, René
  • Gauthier, Geneviève
  • Lalancette, Simon

Abstract

The paper proposes in a regime-shift framework, an arbitrage-free term structure model based on the target and Fed Funds Rates. Empirical observations suggest that a three-state regime-shift environment associated with FOMC monetary actions is justified. Then, a closed-form solution for zero-coupon bonds is derived where regime-shift risk is priced. The solution is flexible enough to incorporate additional state variables.

Suggested Citation

  • 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.
    • Handle: RePEc:eee:finlet:v:7:y:2010:i:2:p:103-109
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1544-6123(10)00002-4
    Download Restriction: Full text for ScienceDirect subscribers only
    ---><---

    As the access to this document is restricted, you may want to

    for a different version of it.

    References listed on IDEAS

    as
    1. Qiang Dai & Kenneth J. Singleton & Wei Yang, 2007. "Regime Shifts in a Dynamic Term Structure Model of U.S. Treasury Bond Yields," The Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1669-1706, 2007 12.
    2. Consolo, Agostino & Favero, Carlo A., 2009. "Monetary policy inertia: More a fiction than a fact?," Journal of Monetary Economics, Elsevier, vol. 56(6), pages 900-906, September.
    3. 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.
    4. Glenn D. Rudebusch, 2006. "Monetary Policy Inertia: Fact or Fiction?," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December.
    5. Wu, Shu & Zeng, Yong, 2006. "The term structure of interest rates under regime shifts and jumps," Economics Letters, Elsevier, vol. 93(2), pages 215-221, November.
    6. Hamilton, James D, 1996. "The Daily Market for Federal Funds," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 26-56, February.
    7. Kotomin, Vladimir & Winters, Drew B., 2007. "The impact of the return to lagged reserve requirements on the federal funds market," Journal of Economics and Business, Elsevier, vol. 59(2), pages 111-129.
    8. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
    9. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-384, March.
    10. Darrell Duffie & Rui Kan, 1996. "A Yield‐Factor Model Of Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(4), pages 379-406, October.
    11. Monika Piazzesi, 2005. "Bond Yields and the Federal Reserve," Journal of Political Economy, University of Chicago Press, vol. 113(2), pages 311-344, April.
    12. Durham, Garland B., 2003. "Likelihood-based specification analysis of continuous-time models of the short-term interest rate," Journal of Financial Economics, Elsevier, vol. 70(3), pages 463-487, December.
    13. Garcia, Rene & Perron, Pierre, 1996. "An Analysis of the Real Interest Rate under Regime Shifts," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 111-125, February.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. 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, January-A.
    2. 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.
    3. Jing Cynthia Wu & Fan Dora Xia, 2020. "Negative interest rate policy and the yield curve," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 35(6), pages 653-672, September.
    4. repec:wyi:journl:002109 is not listed on IDEAS
    5. Andrew Ang & Allan Timmermann, 2012. "Regime Changes and Financial Markets," Annual Review of Financial Economics, Annual Reviews, vol. 4(1), pages 313-337, October.
    6. Huang, Jia-Ping & Sumita, Ushio, 2015. "Development of computational algorithms for pricing European bond options under the influence of macro-economic conditions," Applied Mathematics and Computation, Elsevier, vol. 251(C), pages 453-468.
    7. Glenn D. Rudebusch, 2010. "Macro‐Finance Models Of Interest Rates And The Economy," Manchester School, University of Manchester, vol. 78(s1), pages 25-52, September.
    8. Sungjun Cho & Liu Liu, 2023. "Correcting estimation bias in regime switching dynamic term structure models," Review of Quantitative Finance and Accounting, Springer, vol. 61(3), pages 1093-1127, October.
    9. Shen, Yang & Siu, Tak Kuen, 2013. "Pricing bond options under a Markovian regime-switching Hull–White model," Economic Modelling, Elsevier, vol. 30(C), pages 933-940.
    10. Bruna, Karel & Tran, Quang Van, 2020. "The central banks’ ability to control variability of money market interest rates: The case of inflation targeting countries," Journal of Economic Behavior & Organization, Elsevier, vol. 176(C), pages 384-402.
    11. Bulkley, George & Giordani, Paolo, 2011. "Structural breaks, parameter uncertainty, and term structure puzzles," Journal of Financial Economics, Elsevier, vol. 102(1), pages 222-232, October.
    12. Bu, Ruijun & Cheng, Jie & Hadri, Kaddour, 2016. "Reducible diffusions with time-varying transformations with application to short-term interest rates," Economic Modelling, Elsevier, vol. 52(PA), pages 266-277.
    13. Frank Asche & Atle Oglend & Petter Osmundsen, 2017. "Modeling UK Natural Gas Prices when Gas Prices Periodically Decouple from the Oil Price," The Energy Journal, , vol. 38(2), pages 131-148, March.
    14. Olivier Coibion & Yuriy Gorodnichenko, 2012. "Why Are Target Interest Rate Changes So Persistent?," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(4), pages 126-162, October.
    15. Eo, Yunjong & Kang, Kyu Ho, 2020. "The effects of conventional and unconventional monetary policy on forecasting the yield curve," Journal of Economic Dynamics and Control, Elsevier, vol. 111(C).
    16. Mustafa Akay & Berat Bayram & Abdullah Kazdal & Muhammed Hasan Yilmaz, 2020. "Investigating Regime-Dependent Dynamics in Country Risk Premium: Evidence from Turkey and Emerging Markets," CBT Research Notes in Economics 2008, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    17. Rita Pimentel & Morten Risstad & Sjur Westgaard, 2022. "Predicting interest rate distributions using PCA & quantile regression," Digital Finance, Springer, vol. 4(4), pages 291-311, December.
    18. Almansour, Abdullah, 2016. "Convenience yield in commodity price modeling: A regime switching approach," Energy Economics, Elsevier, vol. 53(C), pages 238-247.
    19. Sean D. Campbell, 2002. "Specification Testing and Semiparametric Estimation of Regime Switching Models: An Examination of the US Short Term Interest Rate," Working Papers 2002-26, Brown University, Department of Economics.
    20. Kohei Hasui & Teruyoshi Kobayashi & Tomohiro Sugo, 2019. "Irreversible monetary policy at the zero lower bound," Discussion Papers 1906, Graduate School of Economics, Kobe University.
    21. Fabio Antonelli & Alessandro Ramponi & Sergio Scarlatti, 2013. "Option-based risk management of a bond portfolio under regime switching interest rates," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 36(1), pages 47-70, May.

    More about this item

    Keywords

    ;

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:finlet:v:7:y:2010:i:2:p:103-109. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/frl .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.