Regime-Switching Stochastic Volatility and Short-Term Interest Rates

37 Pages Posted: 21 Jul 2001

See all articles by Madhu Kalimipalli

Madhu Kalimipalli

Lazaridis School of Business and Economics, Wilfrid Laurier University

Raul Susmel

University of Houston - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: June 2001

Abstract

In this paper, we introduce regime-switching in a two-factor stochastic volatility model to explain the behavior of short-term interest rates. The regime-switching stochastic volatility (RSV) process for interest rates is able to capture all possible exogenous shocks that could be either discrete, as occurring from possible changes in the underlying regime, or continuous in the form of 'market-news' events. We estimate the model using a Gibbs Sampling based Markov Chain Monte Carlo algorithm that is robust to complex non-linearities in the likelihood function. We compare the performance of our RSV model with the performance of other GARCH and stochastic volatility two-factor models. We evaluate all models with several in-sample and out-of-sample measures. Overall, our results show a superior performance of the RSV two-factor model.

Keywords: Short-term interest rates, stochastic volatility, regime switching, MCMC methods, GARCH models

JEL Classification: G10, G12

Suggested Citation

Kalimipalli, Madhu and Susmel, Raul, Regime-Switching Stochastic Volatility and Short-Term Interest Rates (June 2001). Available at SSRN: https://ssrn.com/abstract=277359 or http://dx.doi.org/10.2139/ssrn.277359

Madhu Kalimipalli (Contact Author)

Lazaridis School of Business and Economics, Wilfrid Laurier University ( email )

Waterloo, Ontario N2L 3C5
Canada
519-884-0710 (Phone)

HOME PAGE: http://www.madhukalimipalli.com/

Raul Susmel

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4763 (Phone)
713-743-4789 (Fax)

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