## Term Structure of Interest Rates with Regime Shifts (2002)

Venue: | Journal of Finance |

Citations: | 78 - 1 self |

### BibTeX

@ARTICLE{Bansal02termstructure,

author = {Ravi Bansal and Hao Zhou},

title = {Term Structure of Interest Rates with Regime Shifts},

journal = {Journal of Finance},

year = {2002}

}

### Years of Citing Articles

### OpenURL

### Abstract

We develop a term structure model where the short interest rate and the market price of risks are subject to discrete regime shifts. Empirical evidence from efficient method of moments estimation provides considerable support for the regime shifts model. Standard models, which include affine specifications with up to three factors, are sharply rejected in the data. Our diagnostics show that only the regime shifts model can account for the well-documented violations of the expectations hypothesis, the observed conditional volatility, and the conditional correlation across yields. We find that regimes are intimately related to business cycles. MANY PAPERS DOCUMENT THAT THE UNIVARIATE short interest rate process can be reasonably well modeled in the time series as a regime switching process ~see Hamilton ~1988!, Garcia and Perron ~1996!!. In addition to this statistical evidence, there are economic reasons as well to believe that regime shifts are important to understanding the behavior of the entire yield curve. For example, business cycle expansion and contraction “regimes ” potentially