Correcting estimation bias in regime switching dynamic term structure models

Sungjun Cho, Liu Liu*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review


This paper extends the minimum-chi-square estimation for affine term structure models to a regime switching framework, and corrects the estimation bias in the regime switching dynamic term structure model. Biases arise as a result of highly persistent bond yields, and bias correction changes the decomposition of medium- and long-term forward rates. The bias-corrected expected short rate accounts for the pronounced moves in forward rates during the 1979–1982 monetary experiment and the financial crisis. The bias-corrected term premium becomes counter-cyclical and more negatively correlated with the short-term yield. Monte Carlo simulation shows that the decomposition of forward rates is more accurate after bias correction.

Original languageEnglish
Pages (from-to)1093-1127
Number of pages35
JournalReview of Quantitative Finance and Accounting
Issue number3
Early online date20 Jul 2023
Publication statusPublished - Oct 2023


  • Regime switching
  • Small sample bias correction
  • Term structure


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