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

Keywords

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

ASJC Scopus subject areas

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

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