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A regime-switching term structure model with observable state variables

Author

Listed:
  • Ferland, René
  • Gauthier, Geneviève
  • Lalancette, Simon

Abstract

The paper proposes in a regime-shift framework, an arbitrage-free term structure model based on the target and Fed Funds Rates. Empirical observations suggest that a three-state regime-shift environment associated with FOMC monetary actions is justified. Then, a closed-form solution for zero-coupon bonds is derived where regime-shift risk is priced. The solution is flexible enough to incorporate additional state variables.

Suggested Citation

  • Ferland, René & Gauthier, Geneviève & Lalancette, Simon, 2010. "A regime-switching term structure model with observable state variables," Finance Research Letters, Elsevier, vol. 7(2), pages 103-109, June.
    • Handle: RePEc:eee:finlet:v:7:y:2010:i:2:p:103-109
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    References listed on IDEAS

    as
    1. Qiang Dai & Kenneth J. Singleton & Wei Yang, 2007. "Regime Shifts in a Dynamic Term Structure Model of U.S. Treasury Bond Yields," The Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1669-1706, 2007 12.
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    More about this item

    Keywords

    C02 E43 G10 G12 Regime-switch Target rate Risk-neutral valuation Markov chains;

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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