Monetary policy and long-term interest rates: An efficient markets approach

This paper is an application of efficient markets theory to analyze empirically the relationship of money supply growth and long-term interest rates. This approach has the advantage over calier research on this subject in that it imposes a theoretical structure on this relationship that flows easier interpretation of the empirical results as well as more powerful statistical tests on the interest of ascertaining the robustness of the results, many different empirical tests are carried out in this paper, and they uniformly do not support the preposition that increases in the money supply are correlated with declines in long rates.     

Modelling the term structure of interest rates: An efficient nonparametric approach

We propose a new approach for estimating the coefficients of the term structure equation by means of the volatility of the interest rates and the slope of the yield curve. One advantage of this approach consists in the fact that the drift and the market price of risk are jointly estimated and need not be individually specified. We then generate trajectories in a test problem to investigate the finite properties of this approach. Our simulation results show that this new approach outperforms the classic nonparametric models in the literature. Finally, an application to USA Treasury Bill data is also illustrated.     

OPEC in world financial markets: Oil prices and interest rates

This article examines the relationship between the real rate of interest in world financial markets and the price of oil. If OPEC cannot be viewed as a ‘small’ participant in world financial markets, and should its savings and portfolio behavior differ from that of the rest of the world, then wealth shifts to or from OPEC would affect world interest rates. Subsequently, this paper examines the magnitude of oil price changes required to elicit a significant interest rate change. Our empirical results shed light on OPEC's behavior, which at times may differ from a pure profit maximizing cartel. The short-run price elasticity of the world demand for oil is -0.04 and the long-run elasticity is -0.10. OPEC itself, as expected, faces higher elasticities of -0.08 and -0.36, respectively. The demand elasticity of oil with respect to ‘world’ GNP is 0.8. A major objective of this paper has been to determine the effect of changes in oil prices on world interest rates, and vice versa. Our results imply that only very large oil price increases will have a significant impact on world interest rates. However, oil prices show a non-negligible sensitivity to changes in world interest rates.     

Dynamic linkages among real interest rates in international capital markets

Short-run and long-run dynamic linkages among weekly real interest rates for G-10 countries are examined using a variety of time-series tests. These tests give special attention to the time-series properties of nominal interest rates, ex-ante expected rates of inflation and real interest rates. Term structure information is used to recover a theoretically consistent measure of ex-ante expected inflation. In-sample and out-of-sample Granger causality tests are also examined to evaluate lead/lag relationships among real interest rates. The results provide strong support for well-integrated markets, particularly in the long run. The results imply leadership roles for the US in international asset markets.     

On the term structure of interest rates

The paper presents a valuation formula for default free bonds for a certain class of tastes when the instantaneously riskfree rate of interest follows a geometric Wiener process. Properties of the resulting term structure of interest rates are studied, and an application of the analysis to the pricing of Treasury Bills is proposed.     

On the term structure of interest rates and the risk of default: An analytical approach

Students of the term structure of interest rates commonly assume the absence of the risk of default. This assumption severely limits the applicability of the results of the term structure theory in the field of corporate finance. In this paper it is explained how the risk of default could be incorporated into the well known unbiased expectations theory and how the resulting model is of direct use for a better understanding of interest rate risk differentials.     

On financial guarantee insurance under stochastic interest rates

We extend the financial guarantee insurance literature by modeling, under stochastic interest rates, private financial guarantees when the guarantor potentially defaults. By performing numerical simulations under plausible parameters values, we characterize the differential impact of the incorporation of stochasticity of interest rates on the valuation of both public and private guarantees.     

Analysis of efficient markets

A simple trading model is presented in which Bayes’ rule is used to aggregate traders’ forecasts about risky assets’ future returns. In this financial market, Bayes’ rule operates like an omnipotent market-maker performing functions that in 1776 Adam Smith attributed to an “invisible hand.” We have analyzed two distinct cases: in the first scenario, the traders’ forecast errors are uncorrelated, and in the second scenario, the traders’ forecast errors are correlated. The contribution of our paper is fourfold: first, we prove that the “efficient market” mean-return can be expressed as a complex linear combination of the traders’ forecasts. The weights depend on the forecast variances, as well as on the correlations among the traders’ forecasts. Second we show that the “efficient” variance is equal to the inverse of the sum of the traders’ precision errors, and is also related to the correlations among the traders’ forecast errors. Third, we prove that the efficient market return is the best linear minimum variance estimator (BLMVE) of the security’s mean return (in the sense that it minimizes the sum of the traders’ mean squared forecast errors). Thus, an efficient market aggregates traders’ heterogeneous information in an optimal way. Fourth, we prove that an efficient market produces a mean return (price) as a Blackwell sufficient (most informative) experiment among all possible aggregated expected return (price) forecasts.     

An arbitrage model of the term structure of interest rates

A formula for the price of default-free discount bonds of all maturities is found using a Black- Scholes type of arbitrage model which is based on the assumption that a portfolio of three default-free discount bonds of distinct maturities can be managed to be a perfect substitute for any other default-free discount bond. The formula relates the price of bonds to the real rate of interest, the anticipated rate of inflation and the equilibrium prices of interest rate and inflation risks. Bond prices are shown to be the expected value of the sure nominal proceeds of the bond discounted to the present at a random discount rate. It is shown that the unbiased expectations hypothesis is in general inconsistent with this model.     

Negative real interest rates

Standard textbook general equilibrium term structure models such as that developed by Cox, Ingersoll, and Ross [1985b. “A Theory of the Term Structure of Interest Rates.” Econometrica 53 (2): 385–407], do not accommodate negative real interest rates. Given this, the Cox, Ingersoll, and Ross [1985b. “A Theory of the Term Structure of Interest Rates.” Econometrica 53 (2): 385–407] ‘technological uncertainty variable’ is formulated in terms of the Pearson Type IV probability density. The Pearson Type IV encompasses mean-reverting sample paths, time-varying volatility and also allows for negative real interest rates. The Fokker–Planck (i.e. the Chapman–Kolmogorov) equation is then used to determine the conditional moments of the instantaneous real rate of interest. These enable one to determine the mean and variance of the accumulated (i.e. integrated) real rate of interest on a bank (or loan) account when interest accumulates at the instantaneous real rate of interest defined by the Pearson Type IV probability density. A pricing formula for pure discount bonds is also developed. Our empirical analysis of short-dated Treasury bills shows that real interest rates in the UK and the USA are strongly compatible with a general equilibrium term structure model based on the Pearson Type IV probability density.     

Information stages in efficient markets

Market efficiency, in its strong form, asserts that asset prices fully reflect all available information. The classical event study methodology attempts to make explicit this link by assuming rigid and universal pre-event, event, and post-event periods. As an alternative, our framework captures the progressive diffusion of information around events as well as the overlapping impacts of separate events. We also illustrate that our approach captures mean-reversion of expected returns and increased volatility around announcement dates. These features reflect latent regime switches and are associated with semi-strong market efficiency.     

Benefits of diversifying investments into emerging markets with time-varying correlations: An Australian perspective

Australian investors can reduce their overall portfolio risk by diversifying into equities from other markets. Emerging markets have attracted significant interest because of their low correlations with Australian equity market returns; however, a number of studies have indicated that correlations between equity returns are increasing over time, so using unconditional estimates of correlations in a portfolio optimization model can result in the selection of a portfolio that may not be optimal.We use an Asymmetric Dynamic Conditional Correlation GARCH model to estimate time-varying correlations and include these correlation estimates in the portfolio optimization model. The assets used for portfolio construction comprise seven emerging market indices that are available to foreign investors. This study finds that, despite increasing correlations, there are still potential benefits for Australian investors who diversify into international emerging markets.     

Covered interest rate parity in emerging markets

This paper finds that while covered interest rate parity holds for large and small triple A rated economies, it holds for emerging markets only for a three-month maturity. For a five-year horizon the size and frequency of violations lead to the conclusion that covered interest rate parity does not hold for longer maturities for Brazil, Chile, Russia and South Korea. Overall this paper finds that aspects of credit risk are the source of violations in CIRP in the long-term capital markets rather than transactions costs or the size of the economy.     

当前经济形势与互换利率走势判断

2010年上半年,利率互换市场交投活跃。随着市场对经济增长和政策运用预期的不断修正,互换利率继1月创出新高后一路振荡下行。预计下半年,在基本面、政策面、资金面和利率自身波动节奏的相互作用下,市场参与者的预期将反复进行修正,互换利率将呈现宽幅震荡。     

Economic news,exchange rates and interest rates

The paper examines the post-October 1979 response of exchange rates and interest rates to the new information contained in the first announcement of fifteen US macroeconomic series. Markets respond primarily to monetary news, but also to news about the trade deficit, domestic inflation, and variables that reflect the state of the business cycle. For all fifteen macroeconomic variables, an increase (decrease) in interest rates is accompanied by an appreciation (depreciation) of the dollar, which is consistent with models that stress price rigidity and absence of purchasing power parity.     

Modelling and forecasting short-term interest rate volatility: A semiparametric approach

This paper employs a semiparametric procedure to estimate the diffusion process of short-term interest rates. The Monte Carlo study shows that the semiparametric approach produces more accurate volatility estimates than models that accommodate asymmetry, level effect and serial dependence in the conditional variance. Moreover, the semiparametric approach yields robust volatility estimates even if the short rate drift function and the underlying innovation distribution are misspecified. Empirical investigation with the U.S. three-month Treasury bill rates suggests that the semiparametric procedure produces superior in-sample and out-of-sample forecast of short rate changes volatility compared with the widely used single-factor diffusion models. This forecast improvement has implications for pricing interest rate derivatives.     

Australian and US interest rate swap markets: comparison and linkages

We investigate and compare the determinants of US and Australian interest rate swap spreads and the linkages between these markets. The slope of the risk‐free term structure is the most significant determinant and its importance is greater for longer terms to maturity. Interest rate levels and, in Australia, the default premium also have some impact. The influences of interest rate volatility, the liquidity premium and (in the USA) the default premium are small or negligible. We hypothesise, and our evidence confirms, that the US swap market significantly affects the Australian swap market but not vice‐versa.     

Why interest rates react to money announcements: An explanation from the foreign exchange market

When the Fed announces a money supply greater than had been expected, interest rates rise. Why? One explanation is that the market raises its estimate of the future rates of money growth and inflation, and bids up nominal interest rates. We offer contrary evidence: on such days the dollar appreciates, not depreciates. An alternative explanation is that the market perceives the change in the money stock as a transitory fluctuation that the Fed will reverse in the future. The anticipated future tightening raises today's real interest rate, causes a capital inflow, and appreciates the dollar, the result in fact observed.