Term Structure of Interest Rates with Regime Shifts

By Ravi Bansal, Hao Zhou. 2001

492 citations recorded by the source corpus.

We develop a term structure model where the short interest rate and the market price of risks are subject to discrete regime shifts. Empirical evidence from efficient method of moments estimation provides considerable support for the regime shifts model. Standard models, which include affine specifications with up to three factors, are sharply rejected in the data. Our diagnostics show that only the regime shifts model can account for the well-documented violations of the expectations hypothesis, the observed conditional volatility, and the conditional correlation across yields. We find that regimes are intimately related to business cycles.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/daf4fa03fa1b6ca5ce64f15fa81f7c31018d8027

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Citations in the corpus

Forecasting: theory and practice (2020, background): “model specifications that are not rejected by formal tests include MS (Ang et al., 2008; Bansal and Zhou, 2002).”
Exact and computationally efficient likelihood‐based estimation for discretely observed diffusion processes (with discussion) (2006, unknown): “See, for example, Bansal and Zhou (2002).”
A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets (2012, unknown): “Using the rare disasters framework of Rietz (1988) and Barro (2006), Farhi and Gabaix (2008) explore the implications of time-variation in disaster risk for return predictability in currency markets.”
Accounting for a Shift in Term Structure Behavior with No‐Arbitrage and Macro‐Finance Models (2005, background): “An exception to this practice is the literature on regimeswitching models of interest rates, including, for example, Hamilton (1988), Ang and Bekaert (2002), Bansal and Zhou (2002), and Dai, Singleton, and Yang (2003).”
Affine Term Structure Models (2010, unknown): “The CAPM-type equation (25) shows that expected excess returns on bonds”
The Empirical Failure of the Expectations Hypothesis of the Term Structure of Bond Yields (2007, background): “…to previous findings that the behavior of the entire yield curve is associated with the state of the business cycle, which may have statistically and economically important first-order effects on expectations of inflation, monetary policy, and nominal interest rates (e.g., Bansal and Zhou (2002)).”
A consumption-based model of the term structure of interest rates ☆ (2006, background): “Bansal and Zhou (2002) study a model with regime switches, and conclude that this type of model can also explain the expectations puzzle.”
Whishart Quadratic Term Structure Models (2003, unknown): “Note that 16 See e.g. Ahn and Thompson (1988), Gray (1996), Evans (2000), Ang and Bekaert (2001), Piazzesi (2003), Das (2002), Bansal and Zhou (2002), Dai, Singleton, and Yang (2003). this nonlinear feature arises while the model is a special affine term structure model.”
Discrete-Time Dynamic Term Structure Models with Generalized Market Prices of Risk (2010, unknown): “Recently, Naik and Lee (1997), Evans (2000), Boudoukh, Richardson, Smith, and Whitelaw (1999), Bansal and Zhou (2002) , Ang and Bekaert (2003), and Dai, Singleton, and Yang (2005), among others, introduce regime switching on top of standard affine term structuremodels and examine its implications f”
Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds (2013, unknown): “Regime-switching models have been proposed as an alternative way to reconcile persistent uctuations with stationary long-run behavior of interest rates (Garcia and Perron 1996, Gray 1996, Bansal and Zhou 2002, Ang, Bekaert, and Wei 2008).”
Term Structure Dynamics in Theory and Reality (2003, background): “In contrast, Bansal and Zhou [2002] allow the market price of risk to vary across regimes, through both the regimedependence of volatility and the regime-dependence of the proportionality constant.”
The Term Structure of Real Rates and Expected Inflation (2008, unknown): “m̂t+1 = log M̂t+1 = −rt − 1 2 λt(st+1) ′λt(st+1)− λt(st+1)′εt+1 (5)”
Time-varying short-horizon predictability ☆ (2008, unknown): “…term spread (TERM), the evidence previously cited regarding the short rate coupled with the findings by Ang and Bekaert (2002b), Ang et al. (2008), Bansal and Zhou (2002), Bansal et al. (2004), and Boudoukh et al. (1999) suggest the inclusion of term spread information improves the ability to…”
What Ties Return Volatilities to Price Valuations and Fundamentals? (2013, unknown): “Using the scores of the likelihood function and the errors of the price and volatility variables, we evaluate the SMM objective function, which serves as an omnibus test statistic [see for example Gray (1996) and Bansal and Zhou (2002)].”