Asymmetric Adjustments of U.S. Interest Rates

Abstract

Literature on dynamics of the term structure of interest rates supports that the adjustment of interest rate spread may be well described by nonlinear time series models. This paper examines the relationship between the 3-Month Treasury Bill Rate (DTB3) and 10-Year Treasury Rate (DSG10) from January 1962 to November 2015 by employing the Markov-switching VEC model, which allows for the asymmetric adjustment of interest rates to the long run equilibrium across regimes. We find that the high-volatility regime more frequently exists prior to the 1990s, and the low-volatility one occurs more often after 1990s. Secondly, with allowing for the distinct short-run adjustment parameters in the MS-VECM setup, we find that the evidence of asymmetric adjustments of interest rates to the long run equilibrium in difference regimes. More specifically, the long-term interest rate adjusts more quickly towards the long run equilibrium in the high-volatility regimes than in the low-volatility one. Moreover, by comparing the impulses response functions of linear and nonlinear models, we find that empirical results could be misleading if the regime shift is not taken into account.