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A regime-switching model to evaluate bonds in a quadratic term structure of interest rates

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  • Raphaël Homayoun Boroumand
  • St�phane Goutte
  • Thomas Porcher

Abstract

In this article, we consider a discrete-time economy in which we assume that the short-term interest rate follows a quadratic term structure in a regime-switching asset process. The possible nonlinear structure and the fact that the interest rate can have different economic or financial trends justify regime-switching quadratic term structure model. Indeed, this regime-switching process depends on the values of a Markov chain with a time-dependent transition probability matrix which can capture the different states (regimes) of the economy. We prove that under this model, the conditional zero-coupon bond price admits a quadratic term structure. Moreover, the stochastic coefficients which appear in this decomposition satisfy an explicit system of coupled stochastic backward recursions.

Suggested Citation

  • Raphaël Homayoun Boroumand & St�phane Goutte & Thomas Porcher, 2014. "A regime-switching model to evaluate bonds in a quadratic term structure of interest rates," Applied Financial Economics, Taylor & Francis Journals, vol. 24(21), pages 1361-1366, November.
  • Handle: RePEc:taf:apfiec:v:24:y:2014:i:21:p:1361-1366
    DOI: 10.1080/09603107.2014.925062
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    Cited by:

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    2. Bekiros, Stelios & Avdoulas, Christos & Hassapis, Christis, 2018. "Nonlinear equilibrium adjustment dynamics and predictability of the term structure of interest rates," International Review of Financial Analysis, Elsevier, vol. 55(C), pages 140-155.

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