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The effects of monetary policy regime shifts on the term structure of interest rates

Author

Listed:
  • Abdymomunov Azamat

    (Federal Reserve Bank of Richmond, 530 East Trade Street, Charlotte, NC 28202, USA)

  • Kang Kyu Ho

    (Department of Economics, Korea University, Seoul, 136-701, Korea)

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.

Suggested Citation

  • Abdymomunov Azamat & Kang Kyu Ho, 2015. "The effects of monetary policy regime shifts on the term structure of interest rates," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 19(2), pages 183-207, April.
    • Handle: RePEc:bpj:sndecm:v:19:y:2015:i:2:p:183-207:n:1
    DOI: 10.1515/snde-2013-0031
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    References listed on IDEAS

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    More about this item

    Keywords

    affine no-arbitrage model; Markov switching process; term structure of interest rates;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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