Regime Switching in Dynamics of Risk Premium: Evidence from SHIBOR

In the light of regime switching and volatility clustering in the dynamics of SHIBOR, regime-switching CIR model (RSCIR) and regime-switching GARCH CIR model (RSCIR-GARCH) are established by introducing regime-switching and GARCH specifications into CIR model successively. Then, a contrast study among CIR, RSCIR and RSCIR-GARCH models is performed based on SHIBOR sample data, which indicates that the regime-switching and GARCH specifications can improve the model fitness significantly and eliminate the ARCH effect in the volatility dynamics. Furthermore, an empirical research is carried out on the risk premium dynamics of SHIBOR based on the RSCIR-GARCH model, and it is found that there are two regimes, that is, the regime of higher interest rate with higher volatility and the regime of lower interest rate with lower volatility, in the dynamics of the term structure and risk premium of SHIBOR.