Abstract
This article proposes an overview of the usefulness of the regime switching approach for building various kinds of bond pricing models and of the roles played by the regimes in these models. Both default-free and defaultable bonds are considered. The regimes can be used to capture stochastic drifts and/or volatilities, to represent discrete target rates, to incorporate business cycles or crises, to introduce contagion, to reproduce zero lower bound spells, or to evaluate the impact of standard or nonstandard monetary policies. From a technical point of view, we stress the key role of Markov chains, Compound Autoregressive (Car) processes, Regime Switching Car processes and multihorizon Laplace transforms.
Original language | English |
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Pages (from-to) | 237-277 |
Number of pages | 41 |
Journal | Journal of Financial Econometrics |
Volume | 12 |
Issue number | 2 |
DOIs | |
Publication status | Published - 1 Jan 2014 |
Keywords
- term structure
- regime switching
- affine models
- car process
- multi-horizon Laplace transform
- contagion
- default risk
- monetary policy
- TERM STRUCTURE MODELS
- FOREIGN-EXCHANGE RISK
- INTEREST-RATES
- RATIONAL-EXPECTATIONS
- ELECTRICITY PRICES
- ASSET ALLOCATION
- FEDERAL-RESERVE
- SHIFTS
- LIQUIDITY
- INFORMATION