The impact of jump risks on nominal interest rates and foreign exchange rates

This article investigates the relationship between the nominal interest rate and inflation and also the forward exchange rate under a general specification of the underlying processes govering the foreign exchange rate. There are three distinct risks that affect the relation between the real rate of interest and the nominal rate namely, consumption risk, diffusion risk, and the existence of jump risks of inflation. Jump risks lower the nominal interest rate because of jump hedging of a nominal bond. The forward exchange rate depends on the expected depreciation of the domestic currency as well as these three risks. As the domestic jump risks increase, the domestic nominal interest rate decreases and the forward exchange rate decreases.     

A theory of the nominal term structure of interest rates

A model of the nominal term structure of interest rates is developedthat has a positive and stationary process for the interestrate and delivers closed form expressions for the prices ofdiscount bonds and European options on bonds. Unlike the one-state-variableversion of the Cox, Ingersoll and Ross (1985) model this model- even in its one-state-variable version - allows the term premiumto change sign as a function of the state and the term to maturity,and also allows for shapes of the yield curve that are observedin the U.S. data but that are disallowed in the Cox, Ingersolland Ross model     

Discretionary monetary policy and the zero lower bound on nominal interest rates

Ignoring the existence of the zero lower bound on nominal interest rates one considerably understates the value of monetary commitment in New Keynesian models. A stochastic forward-looking model with an occasionally binding lower bound, calibrated to the U.S. economy, suggests that low values for the natural rate of interest lead to sizeable output losses and deflation under discretionary monetary policy. The fall in output and deflation are much larger than in the case with policy commitment and do not show up at all if the model abstracts from the existence of the lower bound. The welfare losses of discretionary policy increase even further when inflation is partly determined by lagged inflation in the Phillips curve. These results emerge because private sector expectations and the discretionary policy response to these expectations reinforce each other and cause the lower bound to be reached much earlier than under commitment.     

Monetary rules and the nominal rate of interest under uncertainty

The expected real rate of return on a nominal bond is shown to be equal to the real rate of interest plus a premium for systematic purchasing power risk. The particular monetary rule employed by the central monetary authority affects the entire joint distribution of inflation and aggregate real wealth. Thus, the monetary authority is able to influence the relationship between the real and nominal interest rate not only by affecting the expected rate of inflation but also by affecting the systematic purchasing power risk of fixed nominal claims.     

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.     

Long- and short-term interest rates in a risky world

The paper develops and tests a general equilibrium model in which variability, or risk, affects the choice of portfolios. Our measures of variability include only the variability of unanticipated growth in monetary and non-monetary aggregates, and our tests use data ending with the change in Federal Reserve procedures in October 1979. We find that increased variability of unanticipated money growth raises demands for debt and money, and reduces the demand for real capital. Interest rates on both short- and long-term debt rise by a risk premium. We estimate the size of the risk premium before and after the October 1979 change, and we show that the change in Federal Reserve procedures moved the economy to a less efficient point.     

Temporal aggregation and unit roots in nominal foreign exchange rates

Extant empirical evidence on the logarithm of the daily and weekly spot exchange rates indicates the presence of unit roots. At a lower frequency, however, there is evidence that monthly spot rates do not have a unit root, although the autocorrelation coefficient may be close to one in absolute value. Unlike earlier studies, the present article applies various tests to data with different frequencies and reports evidence suggesting that exchange rates may not have unit roots. Absence of nonstationarity in the observations implies that econometric models may not have to apply any differencing.The authors gratefully acknowledge Hashem Dezhbakhsh for helpful suggestions. Comments are welcome.     

Combining forecasts: some results on exchange and interest rates

The aim of this work is to investigate whether the combination of forecasts plays an important role in the improvement of forecast accuracy Particular attention is paid to: (a) the methods of forecasting (the methods compared are neural networks, fuzzy logic, GARCH models, switching regime and chaotic dynamics); (b) combining the forecasts provided by the different methods. This work has also the aim of revising a short-term econometric forecast using a longer-term forecast. The revision process usually runs the opposite way (revision is made on a longer-term forecast using a short-term one to reflect the current available information, but it is not excluded that it is possible to proceed as described above. Daily data from the financial market is used. Some empirical applications on exchange and interest rates are given.     

Money,interest rates,and risk

This paper analyzes the role of the risk in the form of the volatility of open market interest rates as a factor in the demand for money. We demonstrate, using an inventory theoretic model of money demand, that increases in interest rate volatility will increase the demand for money. We then present empirical evidence that the demand for money has been influenced by alterations in the volatility of open market rates using standard specifications of the demand for money.     

Banking market conditions and deposit interest rates

This paper shows that the impact of market structure on bank deposit interest rates is complex. Both market size structure and multimarket bank presence have independent effects on rates. There is evidence that mid-size banks were more aggressive competitors than other banks, but that the effect of market structure on deposit rates has evolved over time, with mega-banks recently becoming more aggressive competitors. This may be related to the growth of mega-banks in many markets. These findings have implications for existing theories of deposit pricing and, by extension, antitrust policy in banking.     

On forecasting interest rates: An efficient markets perspective

Efficient markets do not preclude economic agents from successfully forecasting movements in short-term interest rates. For brief forecast intervals, however, ex ante changes in long-term rates are sufficiently close to zero that economic agents are not likely to improve upon the no-change prediction of the martingale model. Economic agents, in effect, are not likely to succeed in forecasting short-term movements in long-term interest rates. This paper illustrates the closeness of the martingale approximation for two sets of Canadian interest rates data, emphasizing the importance of the forecast interval. The paper then examines three sets of recorded forecasts of Canadian interest rates and finds results consistent with the theoretical discussion.     

Financial dollarization: The role of foreign-owned banks and interest rates

Why in many economies households and firms borrow and make deposits in foreign currency? Expanding on the existing literature, our framework addresses this question allowing for interest rate differentials and access to foreign funds to play a role in explaining this process of asset substitution or financial dollarization. Using a newly compiled data set on transition economies and employing a standard panel as well as a panel-VAR methodology we find that increasing access to foreign funds leads to higher credit dollarization, while it decreases deposit dollarization. Interest rate differentials matter for the dollarization of both loans and deposits.     

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.     

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.     

Euro and FIBOR interest rates: A continuous time modelling analysis

The introduction of the Euro in January 1999 and the new reference interest rate EURIBOR® which is widely used as the underlying interest rate for Euro denominated derivative contracts have opened up a new area of research in international financial markets. In this paper we estimate single factor models using daily EURIBOR® and FIBOR interest rate data. We also estimate a model allowing a level-GARCH specification and a two factor model. We find evidence of level-volatility effects in both rates.     

The high-frequency response of exchange rates and interest rates to macroeconomic announcements

The joint movements of exchange rates and U.S. and foreign term structures over short-time windows around macro announcements are studied using a 14-year span of high-frequency data. In order to evaluate whether the joint effects can be reconciled with conventional theory, the implications of these joint movements for changes in expected future exchange rates and changes in foreign exchange risk premia are deduced. For several real macro announcements, a stronger than expected release appreciates the dollar today, and must either (i) lower the risk premium for holding foreign currency rather than dollars, or (ii) imply net expected dollar depreciation over the ensuing decade.     

The international financial market and US interest rates

This paper examines the linkages between the Eurodollar and US domestic financial markets. It is shown that using weekly data allows the isolation of significant fluctuations being transmitted between markets in both directions. In particular, financial markets in the US are affected significantly by foreign events.It is impossible to reach precise conclusions about the causes of historical variation in the rates. However, this paper provides evidence that at most 40% of the variation in Eurodollar interest rates over the 1975–1978 period can be traced to domestic US sources and that between about one-fifth and two-thirds of the variation in domestic rates can be traced to foreign sources.     

Liquidity provision,interest rates,and unemployment

The effective liquidity supply of the economy—the weighted-sum of all assets that serve as media of exchange—matters for interest rates and unemployment. We formalize this idea by adding an over-the-counter market with collateralized trades to the Mortensen–Pissarides model. An increase in public liquidity through a higher supply of real government bonds raises the real interest rate, crowding out private liquidity and increasing unemployment. If unemployment is inefficiently high, keeping liquidity scarce can be socially optimal. A liquidity crisis affecting the acceptability of private assets as collateral widens the rate-of-return difference between private and public liquidity, also increasing unemployment.