Exploration of the Brazilian Term Structure in a Hidden Markov Framework

IMF Working Papers, January 1, 2011

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Application: A hidden Markov model of the term structure to modeling the Brazilian swap rate curve.
Main empirical findings:
- Two regimes are identified: a high level and a high volatility regime and a low level and low volatility regime.
- Both regimes are persistent.
- Regime dynamics are explained by the level and the slope of the term structure.
Purpose: Examine the model's characteristics and its performance in describing the cross-sectional and time-series dynamics of the term structure.

Model class: Hidden Markov model applied to the term structure (affine regime, ATSM).
State dynamics: Markov chain / Markov-switching models governing regime transitions.
Drivers emphasized: level, slope, mean reversion, volatility regime, market price considerations.
Estimation approach:
- Bayesian MCMC algorithm.
- Produces consistent standard errors.
- Provides a reliable method for testing the differences between the model parameters.

Subject areas: Econometric analysis, Financial regulation and supervision, Financial services, Inflation, Market risk, Markov-switching models, Prices, Time series analysis, Yield curve.
Keywords: affine regime, ATSM, Brazil, Hidden Markov Models, Inflation, market price, Market risk, Markov chain, Markov-switching models, MCMC, mean reversion, State process, state transition, Term Structure, time series, Time series analysis, volatility regime, WP, Yield curve.

IMF Working Paper — "Exploration of the Brazilian Term Structure in a Hidden Markov Framework" (Richard Munclinger, January 1, 2011).