Discussion paper Series 1 / Volkswirtschaftliches Forschungszentrum der Deutschen Bundesbank 2006,06
Using a stochastic discount factor approach, we derive the exact solution for arbitrage-free bond yields for the case that the short-term interest rate follows a threshold process with the intercept switching endogenously. The yield functions, mapping the one-month rate into n-period yields, respectively. This is in contrast to linear short-rate process which imply an affine yield function. The intervals for which convexity or concavity prevails increase with time to maturity.
Threshold process term structure of interest rates nonlinear yield function