A0424
Title: Term premiums and regime-switching prices of macro risks
Authors: Sun Ho Lee - Korea University (Korea, South) [presenting]
Kyu Ho Kang - Korea University (Korea, South)
Abstract: A time-varying effect of macro factors on term premiums is investigated. We consider an arbitrage-free Nelson-Siegel term structure model of interest rates with possibly unspanned macro factors. In the model, the parameters in the prices of macro risks are assumed to change over time according to a first-order Markov regime-switching process. For regime identification and model choice, we classify two macro factors (real activity and inflation) into three categories: (i) ones with unspanned macro risk, (ii) ones without unspanned macro-risk, or (iii) ones with regime-switching unspanned macro risk. Given the three categories for the two variables, there are a total of $3^2$ combinations. The models with different combinations are estimated and compared using a Bayesian approach. Based on the US monthly data from 1987 to 2008, the model with one regime-switching unspanned macro risk is most supported by the data. Specifically, the real activity contains unspanned information and it has a stronger impact on term premiums during recessions. We also report the results using the zero lower bound period data.
