The effects of monetary policy regime shifts on the term structure of interest rates

Azamat Abdymomunov, Kyu Ho Kang

Research output: Contribution to journalArticle

1 Citation (Scopus)

Abstract

We investigate how the entire term structure of interest rates is influenced by changes in monetary policy regimes. To do so, we develop and estimate an arbitrage-free dynamic term-structure model which accounts for regime shifts in monetary policy and price of risk. Our results for US data from 1985 through 2008 indicate that (i) the Federal Reserve's reaction to inflation has changed over time, switching between "active" and "passive" monetary policy regimes; (ii) on average, the term spread in the "active" regime was wider than in the "passive" regime; and (iii) the yields in the "active" regime were considerably more volatile than in the "passive" regime. The wider term spread in the "active" regime reflects higher term premia associated with a more sensitive response of the short-term interest rate to inflation. Additionally, our analysis suggests that the model fit improves substantially when we account for regime switching in monetary policy and price of risk.

Original languageEnglish
Pages (from-to)183-207
Number of pages25
JournalStudies in Nonlinear Dynamics and Econometrics
Volume19
Issue number2
DOIs
Publication statusPublished - 2015 Apr 1

Fingerprint

Term Structure of Interest Rates
Monetary Policy
monetary policy
interest rate
regime
Inflation
Term
Regime Switching
Term Structure
Arbitrage
Volatiles
inflation
Interest Rates
Entire
Regime shift
Monetary policy regimes
Term structure of interest rates
Model
Estimate

Keywords

  • affine no-arbitrage model
  • Markov switching process
  • term structure of interest rates

ASJC Scopus subject areas

  • Economics and Econometrics
  • Social Sciences (miscellaneous)
  • Analysis

Cite this

The effects of monetary policy regime shifts on the term structure of interest rates. / Abdymomunov, Azamat; Kang, Kyu Ho.

In: Studies in Nonlinear Dynamics and Econometrics, Vol. 19, No. 2, 01.04.2015, p. 183-207.

Research output: Contribution to journalArticle

@article{811b79989cf24aecb5b91a15e4b17bf8,
title = "The effects of monetary policy regime shifts on the term structure of interest rates",
abstract = "We investigate how the entire term structure of interest rates is influenced by changes in monetary policy regimes. To do so, we develop and estimate an arbitrage-free dynamic term-structure model which accounts for regime shifts in monetary policy and price of risk. Our results for US data from 1985 through 2008 indicate that (i) the Federal Reserve's reaction to inflation has changed over time, switching between {"}active{"} and {"}passive{"} monetary policy regimes; (ii) on average, the term spread in the {"}active{"} regime was wider than in the {"}passive{"} regime; and (iii) the yields in the {"}active{"} regime were considerably more volatile than in the {"}passive{"} regime. The wider term spread in the {"}active{"} regime reflects higher term premia associated with a more sensitive response of the short-term interest rate to inflation. Additionally, our analysis suggests that the model fit improves substantially when we account for regime switching in monetary policy and price of risk.",
keywords = "affine no-arbitrage model, Markov switching process, term structure of interest rates",
author = "Azamat Abdymomunov and Kang, {Kyu Ho}",
year = "2015",
month = "4",
day = "1",
doi = "10.1515/snde-2013-0031",
language = "English",
volume = "19",
pages = "183--207",
journal = "Studies in Nonlinear Dynamics and Econometrics",
issn = "1081-1826",
publisher = "Berkeley Electronic Press",
number = "2",

}

TY - JOUR

T1 - The effects of monetary policy regime shifts on the term structure of interest rates

AU - Abdymomunov, Azamat

AU - Kang, Kyu Ho

PY - 2015/4/1

Y1 - 2015/4/1

N2 - We investigate how the entire term structure of interest rates is influenced by changes in monetary policy regimes. To do so, we develop and estimate an arbitrage-free dynamic term-structure model which accounts for regime shifts in monetary policy and price of risk. Our results for US data from 1985 through 2008 indicate that (i) the Federal Reserve's reaction to inflation has changed over time, switching between "active" and "passive" monetary policy regimes; (ii) on average, the term spread in the "active" regime was wider than in the "passive" regime; and (iii) the yields in the "active" regime were considerably more volatile than in the "passive" regime. The wider term spread in the "active" regime reflects higher term premia associated with a more sensitive response of the short-term interest rate to inflation. Additionally, our analysis suggests that the model fit improves substantially when we account for regime switching in monetary policy and price of risk.

AB - We investigate how the entire term structure of interest rates is influenced by changes in monetary policy regimes. To do so, we develop and estimate an arbitrage-free dynamic term-structure model which accounts for regime shifts in monetary policy and price of risk. Our results for US data from 1985 through 2008 indicate that (i) the Federal Reserve's reaction to inflation has changed over time, switching between "active" and "passive" monetary policy regimes; (ii) on average, the term spread in the "active" regime was wider than in the "passive" regime; and (iii) the yields in the "active" regime were considerably more volatile than in the "passive" regime. The wider term spread in the "active" regime reflects higher term premia associated with a more sensitive response of the short-term interest rate to inflation. Additionally, our analysis suggests that the model fit improves substantially when we account for regime switching in monetary policy and price of risk.

KW - affine no-arbitrage model

KW - Markov switching process

KW - term structure of interest rates

UR - http://www.scopus.com/inward/record.url?scp=84925409393&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=84925409393&partnerID=8YFLogxK

U2 - 10.1515/snde-2013-0031

DO - 10.1515/snde-2013-0031

M3 - Article

AN - SCOPUS:84925409393

VL - 19

SP - 183

EP - 207

JO - Studies in Nonlinear Dynamics and Econometrics

JF - Studies in Nonlinear Dynamics and Econometrics

SN - 1081-1826

IS - 2

ER -