RFS Advance Access originally published online on April 12, 2007
Review of Financial Studies 2007 20(5):1669-1706; doi:10.1093/rfs/hhm021
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Regime Shifts in a Dynamic Term Structure Model of U.S. Treasury Bond Yields
New York University
Stanford University
University of Rochester
Address correspondence to Wei Yang William E. Simon, Graduate School of Business Administration, University of Rochester, Rochester, NY 14627, or e-mail: wei.yang{at}simon.rochester.edu
JEL: G12
 |
Abstract |
|---|
This article develops and empirically implements an arbitrage-free, dynamic term structure model with "priced" factor and regime-shift risks. The risk factors are assumed to follow a discrete-time Gaussian process, and regime shifts are governed by a discrete-time Markov process with state-dependent transition probabilities. This model gives closed-form solutions for zero-coupon bond prices, an analytic representation of the likelihood function for bond yields, and a natural decomposition of expected excess returns to components corresponding to regime-shift and factor risks. Using monthly data on U.S. Treasury zero-coupon bond yields, we show a critical role of priced, state-dependent regime-shift risks in capturing the time variations in expected excess returns, and document notable differences in the behaviors of the factor risk component of the expected returns across high and low volatility regimes. Additionally, the state dependence of the regime-switching probabilities is shown to capture an interesting asymmetry in the cyclical behavior of interest rates. The shapes of the term structure of volatility of bond yield changes are also very different across regimes, with the well-known hump being largely a low-volatility regime phenomenon.
We are grateful for financial support from the Gifford Fong Associates Fund, at the Graduate School of Business, Stanford University.
CiteULike 
Connotea 
Del.icio.us What's this?
This article has been cited by other articles:
|
|
 |
|
  M. S. Johannes, N. G. Polson, and J. R. Stroud Optimal Filtering of Jump Diffusions: Extracting Latent States from Asset Prices Rev. Financ. Stud., July 1, 2009; 22(7): 2759 - 2799. [Abstract] [Full Text] [PDF]
|
|
|
|
 |
|
 H. Bertholon, A. Monfort, and F. Pegoraro Econometric Asset Pricing Modelling J. Financial Econometrics, October 1, 2008; 6(4): 407 - 458. [Abstract] [Full Text] [PDF]
|
|