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Monetary Policy Regimes: Implications for the Yield Curve and Bond Pricing
Type
working paper
Date Issued
2013
Author(s)
Abstract
We develop a multivariate dynamic term structure model, which takes into account the nonlinear (time-varying) relationship between interest rates and the state of the economy. In contrast to the classical term structure literature, where nonlinearities are captured by increasing the number of latent state variables, or by latent regime shifts, in our no-arbitrage framework the regimes are governed by thresholds and are directly linked to different economic fundamentals. Specifically, starting from a simple monetary policy model for the short rate, we introduce a parsimonious and tractable model for the yield curve, which takes into account the possibility of regime shifts in the behavior of the Federal Reserve. In our empirical analysis, we show the merit of our approach along four dimensions: (i) interpretable bond dynamics; (ii) accurate short end yield curve pricing; (iii) yield curve implications; (iv) superior out-of-sample short rate forecasting performance.
Language
English
Keywords
Threshold regime switching model
Macroeconomic variables
Term structure of interest rates
Asset pricing
Nonlinear dynamics
Business cycles
HSG Classification
contribution to scientific community
HSG Profile Area
SEPS - Quantitative Economic Methods
Refereed
No
Publisher
http://ssrn.com/abstract=2232742
Subject(s)
Eprints ID
221675