An infinite hidden Markov model for short-term interest rates

The time-series dynamics of short-term interest rates are important as they are a key input into pricing models of the term structure of interest rates. In this paper we extend popular discrete time short-rate models to include Markov switching of infinite dimension. This is a Bayesian nonparametric model that allows for changes in the unknown conditional distribution over time. Applied to weekly U.S. data we find significant parameter change …