Regime-Switching Behavior of the Term Structure of Forward Markets

This paper presents techniques for modelling and estimating the behavior of financial market price or return differentials that follow non-linear regime-switching behaviour. The methodology to be used here is estimation of variants of threshold autoregression (TAR) models. In the basic model the differentials are random within a band defined by transactions costs and contract risk; they occasionally jump outside the band, and then follow an autoregressive path back towards the band. The principal reference is Tchernykh (1998). The application here is to deviations from covered interest parity (CIP) between forward foreign exchange (FX) markets in Hong Kong and the Philippines. We have observed that these deviations from the band follow irregular steps, rather than single jumps. Therefore a Modified TAR model (MTAR) that allows for this behaviour is also estimated. The estimation methodology is a regime-switching maximum likelihood procedure. The estimates can provide indicators for policy-makers of the market's expectation of crisis, and could also provide indicators for the private sector of convergence of deviations to their usual bands. The TAR model has the potential to be applied to differentials between linked pairs of financial market prices more generally.

Application of a Modified TAR Model to CIP Deviations in Asian Data

The methodology to be used in this paper is estimation of a threshold autoregressive (TAR) model. In this model deviations are random within a band defined by transactions costs and contract risk, and autoregressive towards the band outside it. The principal reference is Tchernykh (1998). These estimates can provide indicators for policy-makers of the market¡¦s expectation of crisis. They could also provide indicators for the private sector of convergence of deviations to their usual bands. The estimation methodology is a non-linear three-regime maximum likelihood procedure. The TAR model has the potential to be applied to differentials between linked pairs of financial market prices more generally. This paper modifies the classical TAR model to allow for progressive deviations from a stochastic regime, rather than simple jumps.

Asymmetric arbitrage and default premiums between the US and Russian financial markets

Deviations from covered interest rate parity (CIP) and from a generalized form of CIP involving forward forward arbitrage between the Russian Treasury bill (GKO) market and the U.S. Treasury bill market are modeled nonlinearly. We find a noarbitrage band within which deviations are random, outside of which deviations revert to the edge of the band. The band is asymmetric, implying that small profit margins trigger arbitrage into the dollar, but large profit margins are needed to trigger arbitrage into the ruble. The bandwidth rises and the speed of mean reversion falls as the maturity increases. The findings are consistent with the existence of Russian default premiums