Corporate Bond Yield Curve Modeling: A Rating-Based Regime-Switching Generalized CIR Approach

TL;DR

This paper introduces a regime-switching generalized CIR model for Chinese bond markets, capturing interest rate regimes and credit risk dynamics to improve yield curve modeling and risk assessment.

Contribution

It develops a novel two-block, arbitrage-free regime-switching model that jointly prices government and corporate bond curves using a recursive filtering approach.

Findings

Identifies two persistent interest rate regimes with distinct profiles.

Regime switching enhances fit and interpretability of bond yield models.

Improves decomposition of corporate yields into discounting and credit components.

Abstract

Persistent shifts in term-structure dynamics undermine the stability of single-regime models in long samples. We develop an arbitrage-free regime-switching generalized CIR (RS-GCIR) model that jointly prices the Chinese government bond (CGB) curve and corporate bond curves. To capture the systematic transmission from interest-rate conditions to credit spreads, we structure the model into two blocks and price corporate bonds conditional on the prevailing rate regime. The rate block features a two-state RS-GCIR short-rate process estimated from CGB zero-coupon curves, while the credit block embeds CIR-type credit factors in an intensity-based framework for rating migration and default. We implement a block-recursive Unscented Kalman Filter (UKF) procedure--filtering the rate block first and the credit block next--using weekly data from 2014--2025, a period that begins with the onset of China's modern corporate default cycle. We identify two persistent rate regimes with distinct level--volatility profiles. Relative to single-regime benchmarks, regime switching improves joint curve fit, delivers economically interpretable filtered regime probabilities, and sharpens the decomposition of corporate yields into discounting and credit compensation.