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South African Historical Interest Rate Volatility - Evidence of Regime- Switching


  • S. Kennedy-Palmer


Accurate estimates of volatility are important for the valuation and risk management of financial assets. The benchmark interest rate for many assets in South Africa, the 3-month Jibar, is found to exhibit a high volatility persistence when modelled with a standard generalised autoregressive conditional heteroskedasticity (GARCH) process. The literature suggests that unobserved regime-switching in interest rate data may lead to an overestimation of volatility persistence. In this study 120 GARCH-type volatility models are tested to determine which model, conditional distribution and number of regimes best fit the data in order to extract the most accurate in-sample estimation of historical volatility for asset pricing. The data analysed consists of 877 weekly observations of 3-month Jibar in total, spanning from September 2001 to July 2018. The switching between regimes is governed by a Markov chain process which produces state-dependent transition probabilities for the unobserved regimes. The study finds that a standard single regime GARCH model may not capture the underlying volatility dynamics of the interest rate. The best performing model in this study is the 4 State Threshold-GARCH indicating that in addition to evidence of regime-switching in the data, there is an asymmetric reaction to negative information.

Suggested Citation

  • S. Kennedy-Palmer, 2019. "South African Historical Interest Rate Volatility - Evidence of Regime- Switching," Studies in Economics and Econometrics, Taylor & Francis Journals, vol. 43(3), pages 111-132, December.
  • Handle: RePEc:taf:rseexx:v:43:y:2019:i:3:p:111-132
    DOI: 10.1080/10800379.2019.12097353

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