A Dynamic Nelson-Siegel Yield Curve Model with Markov Switching

This paper proposes a model to better capture persistent regime changes in the interest rates of the US term structure. While the previous literature on this matter proposes that regime changes in the term structure are due to persistent changes in the conditional mean and volatility of interest rates we find that changes in a single parameter of the model we use better models regime changes. Furthermore, we investigate if the effects of macroeconomic phenomena such monetary policy, inflation expectations, and real business activity differ according to the particular regime realized for the term structure. Our results indicate that in periods of low interest rates, monetary policy and real business activity have a greater effect on the longer maturities of the yield curve than in high interest rate regimes. In those periods of high interest rate regimes, inflation expectations have a greater effect in yield determination for longer maturities. (JEL: C51, E43)