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Regime Switches in Interest Rates

71 Pages Posted: 12 Jul 2000  

Geert Bekaert

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Andrew Ang

BlackRock, Inc

Multiple version iconThere are 2 versions of this paper

Date Written: April 1998

Abstract

Regime-switching models are well suited to capture the non-linearities in interest rates. This paper examines the econometric performance of regime-switching models for interest rate data from the US, Germany and the UK. There is strong evidence supporting the presence of regime switches but univariate models are unlikely to yield consistent estimates of the model parameters. Regime-switching models incorporating international short rate and term spread information forecast better, match sample moments better, and classify regimes better than univariate models. We show that the regimes in interest rates correspond reasonably well with business cycles, at least in the US. This may explain why regime-switching models forecast interest rates better than single regime models. Finally, the non-linear interest rate dynamics implied by regime-switching models have potentially important implications for the macroeconomic literature documenting the effects of monetary policy shocks on economic aggregates. Moreover, the implied volatility and drift functions are rich enough to resemble those recently estimated using non-parametric techniques.

Suggested Citation

Bekaert, Geert and Ang, Andrew, Regime Switches in Interest Rates (April 1998). NBER Working Paper No. w6508. Available at SSRN: https://ssrn.com/abstract=226250

Geert Bekaert

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Andrew Ang (Contact Author)

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

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