The Fed – Are Shadow Rate Models of the Treasury Yield Curve Structurally Stable?

August 2020

Are Shadow Rate Models of the Treasury Yield Curve Structurally Stable?

Don H. Kim and Marcel A. Priebsch


We examine the structural stability of Gaussian shadow rate term structure models of Treasury yields over a sample that includes the period from 2008 onwards during which the U.S. policy rate was at its effective lower bound. After a conceptual discussion of several potential sources of a structural break in the context of the shadow rate model, we document various pieces of evidence for structural instability based on predictive tests and Lagrange multiplier tests, as well as with separate estimations of the pre-ELB and post-ELB subsamples. In order to overcome the diffculties associated with the latent-factor nature of the model in testing for a structural break, we focus on objects that can be given intuitive interpretation, such as principal components, or that are constructed to be invariant to factor rotations.

Keywords: Shadow rate term structure models, Treasury yields, ELB, structural break, structural instability, factor rotations, principal components


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Last Update:
August 20, 2020

Source: Federal Reserves

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