Large-dimensional cointegrated threshold factor models: The Global Term Structure of Interest Rates

We extend the two-level factor model to account for cointegration between groupspecific factors in large datasets. We propose two nonlinear specifications: (i) a threshold vector error correction model (VECM) that accounts for asymmetric responses across regimes; and (ii) a band VECM that captures discontinuous state-dependent adjustment which activates only when deviations from equilibrium exceed a certain threshold. We examine the small-sample performance of both models through Monte Carlo simulations. In an empirical application, we estimate a band factor VECM on a panel of government bond yields from multiple countries, estimating one global factor and two group-specific factors associated with long- and short-term maturities. The results provide evidence of a discontinuous adjustment in the global term structure of interest rates.