FIN-03-040 |
NYU Stern School of Business |
October 2003
Qiang Dai, Kenneth J. Singleton, and Wei Yang
ABSTRACT
This paper develops and empirically implements an arbitrage-free,
dynamic term structure model with "priced" factor and
regime-shift risks. The risk factors are assumed to follow a
discrete-time Gaussian process, and regime shifts are governed by a
discrete-time Markov process with state-dependent transition
probabilities. This model gives closed-form solutions for zero-coupon
bond prices and an analytic representation of the likelihood function
for bond yields. Using monthly data on U.S. Treasury zero-coupon bond
yields, we document notable differences in the behaviours of the market
prices of factor risk across high and low volatility regimes.
Additionally, the state-dependence of the regime-switching
probabilities is shown to capture an interesting asymmetry in the
cyclical behaviour of interest rates. The shapes of the term
structures of bond yield volatilities are also very different across
regimes, with the well-known hump in volatility being largely a
low-volatility regime phenomenon.
Qiang Dai
Institution: Stern School of Business, New York University
Phone: (212) 998-0358
Fax: (212) 995-4233
Email: qdai@stern.nyu.edu
Home Page: http://www.stern.nyu.edu/~qdai
Kenneth J.Singleton
Institution: Graduate School of Business, Stanford University, Stanford, CA 94305
Email: ken@future.stanford.edu
Wei Yang
Institution: Student, Graduate School of Business, Stanford University, Stanford, CA 94305
Email: wy29@stanford.edu
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