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 language | English |
|---|---|
| Pages (from-to) | 183-207 |
| Number of pages | 25 |
| Journal | Studies in Nonlinear Dynamics and Econometrics |
| Volume | 19 |
| Issue number | 2 |
| DOIs | |
| Publication status | Published - 2015 Apr 1 |
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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 journal › Article
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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 -