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Nonlinear mean reversion in the term structure of interest rates

✍ Scribed by Byeongseon Seo

Publisher: Elsevier Science
Year: 2003
Tongue: English
Weight: 370 KB
Volume: 27
Category: Article
ISSN: 0165-1889
DOI: 10.1016/s0165-1889(02)00124-0

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✦ Synopsis

The expectations hypothesis implies that the yield curve provides information on the future change in the short-term interest rate. However, transaction costs exist in the ÿnancial market, which prevent investors from realizing the arbitrage opportunity, when the arbitrage does not fully cover the transaction costs. The purpose of this paper is to assess the e ect of transaction costs on the predictability of the term structure by using the threshold vector error correction model, which allows for the nonlinear adjustment to the long-run equilibrium relationship. A signiÿcant amount of threshold e ect is found, and the adjustment coe cients are regime-dependent. The empirical result supports the nonlinear mean reversion in the term structure of interest rates.

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