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A Switching Regime Model for Interest Rates in Continuous Time

Objective



Research objectives and content

The objective of my research is to model explicitly the role of the central bank in shaping the yield curve and to estimate the model using continuous time econometrics techniques. The originality of this project consists in developing a simple model where the central bank reacts to changes in the economic environment by changing a reference interest rate. A Vasicek type model, where the mean reverting level evolves stochastically over time according to a continuous time Markov chain, will be adopted. To put it in a different way, we model the changes in the mean reverting level as conditional switches between a finite number of values. This switching regime assumption is a novelty and it implies that the possible alternative states and the probabilities to reach them can depend on the current state and on some exogenous variable. In the second part of my work, I would like to estimate the model using continuous time econometric techniques. I expect that the application of these techniques to a switching regime model will resolve two problems that have emerged in the empirical literature: the discretisation problem and the insufficient specification of the drift term.

Training content (objective, benefit and expected impact)

For the theoretical development of my research, the contact with the host institution has already been found very stimulating since important work on the same field has been done there. Therefore, carrying out my research at Birkbeck College will give me direct access to essential resources that are going to be critical to complete successfully my project. From the training, I expect to attain a comprehensive knowledge of financial theory and gain a thorough knowledge of the most up-to-date financial econometric techniques required to complete my research project.

Links with industry / industrial relevance (22)

Funding Scheme

RGI - Research grants (individual fellowships)

Coordinator

Birkbeck College - University of London
Address
Gresse Street
W1P 2LL London
United Kingdom