Short Rate Nonlinearities and Regime Switches
37 Pages Posted: 8 Dec 2000
Date Written: October 23, 2000
Using non-parametric estimation methods, various authors have shown distinct non-linearities in the drift and volatility function of the US short rate, which are inconsistent with standard affine term structure models. We document how a regime-switching model with state dependent transition probabilities between regimes can replicate the patterns found by the non-parametric studies. To do so, we use data from the UK and Germany in addition to US data and include term spreads in some of our models. We also examine the drift and volatility function of the term spread.
Keywords: Short rate, term spread, drift, volatility, regime-switching
JEL Classification: C22, C32, E43, G12
Suggested Citation: Suggested Citation