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Regime Switches in Interest Rates

Author

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  • Andrew Ang
  • Geert Bekaert
Abstract
Regime-switching models are well suited to capture the non-linearities in interest rates. This paper examines the econometric performance of regime-switching models for interest rate data from the US, Germany and the UK. There is strong evidence supporting the presence of regime switches but univariate models are unlikely to yield consistent estimates of the model parameters. Regime-switching models incorporating international short rate and term spread information forecast better, match sample moments better, and classify regimes better than univariate models. We show that the regimes in interest rates correspond reasonably well with business cycles, at least in the US. This may explain why regime-switching models forecast interest rates better than single regime models. Finally, the non-linear interest rate dynamics implied by regime-switching models have potentially important implications for the macroeconomic literature documenting the effects of monetary policy shocks on economic aggregates. Moreover, the implied volatility and drift functions are rich enough to resemble those recently estimated using non-parametric techniques.

Suggested Citation

  • Andrew Ang & Geert Bekaert, 1998. "Regime Switches in Interest Rates," NBER Working Papers 6508, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:6508
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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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