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

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Listed:
  • 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

Suggested Citation

  • Yong Zeng & Shu Wu, 2004. "A General Equilibrium Model of the Term Structure of Interest Rates under Regime-switching Risk," Econometric Society 2004 North American Summer Meetings 304, Econometric Society.
  • Handle: RePEc:ecm:nasm04:304
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    File URL: http://repec.org/esNASM04/up.24288.1075421015.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    The Term Structure; General Equilibrium; Markov Regime Shifts;

    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

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