Regime Switching Stochastic Volatility and Short-Term Interest Rates

Posted: 6 Nov 2003

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

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Abstract

In this paper, we introduce regime-switching in a two-factor stochastic volatility (SV) model to explain the behavior of short-term interest rates. We model the volatility of short-term interest rates as a stochastic volatility process whose mean is subject to shifts in regime. We estimate the regime-switching stochastic volatility (RSV) model using a Gibbs Sampling-based Markov Chain Monte Carlo algorithm. In-sample results strongly favor the RSV model in comparison to the single-state SV model and GARCH family of models. Out-of-sample results are mixed and, overall, provide weak support for the RSV model.

JEL Classification: G10, G12

Suggested Citation

Kalimipalli, Madhu and Susmel, Raul, Regime Switching Stochastic Volatility and Short-Term Interest Rates. Journal of Empirical Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=461080

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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