DP4165 On Model Selection and Markov Switching: A Empirical Examination of Term Structure Models with Regime Shifts

Author(s):	John Driffill, Turalay Kenc, Martin Sola, Fabio Spagnolo
Publication Date:	January 2004
Keyword(s):	bond yields, regime switching, stochastic discount factor/pricing kernel, term structure of interest rates
JEL(s):	E43, G12
Programme Areas:	International Macroeconomics, Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=4165

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.