Working Paper: CEPR ID: DP4165
Authors: John Driffill; Turalay Kenc; Martin Sola; Fabio Spagnolo
Abstract: We examine several continuous-time term-structure models, in which the short rate is subject to discrete shifts. Our empirical analysis suggests that inquiring which parameters of the short-term interest rate equation are allowed to switch is crucial, as failing to do so may result in switching pricing models that produce no improvement (in terms of pricing) with respect to models which do not allow for regime switching, even when there are clear breaks in the data.
Keywords: bond yields; regime switching; stochastic discount factor; pricing kernel; term structure of interest rates
JEL Codes: E43; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| model specification (C52) | pricing performance (L11) |
| regime shifts in volatility and long-run values (C22) | pricing accuracy (L11) |
| simpler models with regime-dependent volatility (C22) | pricing accuracy (L11) |
| complexity of the model (C52) | pricing accuracy (L11) |