the dynamics and causes of real interest rate differentials: an investigation for developed and...
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The Dynamics and Causes of Real Interest The Dynamics and Causes of Real Interest Rate Differentials: An Investigation for Rate Differentials: An Investigation for
Developed and Emerging MarketsDeveloped and Emerging Markets
PhD ProjectAlex Luiz Ferreira
Supervisors:
Dr. Miguel A. León-Ledesma & Prof. Roger Vickerman
Department of Economics, University of Kent, UK
Is there any evidence of real Is there any evidence of real interest rate differentials in a set of interest rate differentials in a set of
emerging and developed emerging and developed economies?economies?
Yes
What are the underlying causes of the differentials?
Motivation and RelevanceMotivation and Relevance
Interest Payments versus Income Growth: Default Possibility
Public Accounts: Interest Payments versus other Expenditures
Market Integration
Independent Monetary Policy
Mixed evidence: Pioneers are Mishkin (1984) and Cumby and Obstfeld (1984)
Structure of the ThesisStructure of the Thesis
– Chapter 1.Chapter 1. Real Interest Rate Parity: Theory and Evidence Real Interest Rate Parity: Theory and Evidence Literature ReviewLiterature Review
– Chapter 2.Chapter 2. Does the Real Interest Rate Parity Hold? Evidence Does the Real Interest Rate Parity Hold? Evidence for Developed and Emerging Marketsfor Developed and Emerging Markets
First Research QuestionFirst Research Question
– Chapter 3.Chapter 3. The Dynamics of Interest Rate Differentials The Dynamics of Interest Rate Differentials Blanchard and Quah (1989) variance decompositionBlanchard and Quah (1989) variance decomposition
– Chapter 4.Chapter 4. Breaking Down UIRP: Risk and Uncertainty Breaking Down UIRP: Risk and Uncertainty
– Chapter 5.Chapter 5. Investigating the Causes of Default Risk and Investigating the Causes of Default Risk and Exchange Rate UncertaintyExchange Rate Uncertainty
Does the Real Interest Parity Does the Real Interest Parity Hypothesis Hold? Evidence for Hypothesis Hold? Evidence for
Developed and Emerging Developed and Emerging MarketsMarkets
Department of Economics, University of Kent, UK
Alex Luiz FerreiraMiguel Leon-Ledesma
Working Paper 0301
Is there evidence of real interest rate Is there evidence of real interest rate equalisation in a sample of equalisation in a sample of
developed and emerging markets in developed and emerging markets in the recent period of liberalised trade the recent period of liberalised trade
and capital flows?and capital flows?
How does the behaviour of the two groups of countries compare? Are there any patterns that may explain their different behaviour?
Motivation and ContributionMotivation and Contribution
– Mixed evidence and Default PossibilityMixed evidence and Default Possibility– Market IntegrationMarket Integration
focus on focus on postpost liberalisation period (from 1995:3 to 2002:5) liberalisation period (from 1995:3 to 2002:5) inclusion of emerging markets: inclusion of emerging markets: Argentina, Brazil, Chile, Mexico Argentina, Brazil, Chile, Mexico
and Turkeyand Turkey Countries supposed to be well integrated: Countries supposed to be well integrated: France, Italy, Spain France, Italy, Spain
and UK; Germany and USA as reference countriesand UK; Germany and USA as reference countries
– TechniquesTechniques Few Unit Root TestsFew Unit Root Tests:: Meese and Rogoff (1988), Edison and Pauls Meese and Rogoff (1988), Edison and Pauls
(1993) and Obstfeld and Taylor (2002); Advantage over Cointegration.(1993) and Obstfeld and Taylor (2002); Advantage over Cointegration.
More Powerful TechniquesMore Powerful Techniques – KPSS (1992), ERS (1996), Elliot (1999) KPSS (1992), ERS (1996), Elliot (1999) – Structural Breaks - Perron (1997)Structural Breaks - Perron (1997)
Asymmetries are Taken into AccountAsymmetries are Taken into Account– M-Tar ModelM-Tar Model
Real Interest Rate Parity Hypothesis (RIPH)Real Interest Rate Parity Hypothesis (RIPH)
0 1 12
p
t t i t i ti
rid a rid rid
0
0
00 and 0a
00 and 0a
01 0
1
( ) 0 1 and 01t
aE rid a a
a
• Explosive
• Unit Root
• Persistent or Short-Lived
• Permanent
• RIPH
• General Stochastic Process
1
1q
ii
a
ridsridsArgentina
1995 1996 1997 1998 1999 2000 2001-1
0
1
2
3
4
5
6
7Ger
US
Brazil
1995 1996 1997 1998 1999 2000 20010.0
2.5
5.0
7.5
10.0
12.5
15.0GerUS
• 3 month compounded yield on Treasury Bill or Dep. Rates; CPI
Chile
1995 1996 1997 1998 1999 2000 2001-1.6
-0.8
0.0
0.8
1.6
2.4
3.2
4.0
4.8USGer
Mexico
1995 1996 1997 1998 1999 2000 2001-1.8
-0.9
0.0
0.9
1.8
2.7
3.6
4.5
5.4USGer
ridsrids
Spain
1995 1996 1997 1998 1999 2000 2001-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0USGer
Italy
1995 1996 1997 1998 1999 2000 2001-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0USGer
• 3 month compounded yield on Treasury Bill or Dep. Rates; CPI
France
1995 1996 1997 1998 1999 2000 2001-1.0
-0.5
0.0
0.5
1.0
1.5
2.0USGer
UK
1995 1996 1997 1998 1999 2000 2001-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0USGer
ridsrids
• 3 month compounded yield on Treasury Bill or Dep. Rates; CPI
Turkey
1995 1996 1997 1998 1999 2000 2001-5
0
5
10
15
20
25USGer
US and Germany
1995 1996 1997 1998 1999 2000 2001-1.6
-1.2
-0.8
-0.4
-0.0
0.4
0.8
1.2
1.6GerUS
Unit Root TestsUnit Root Tests ADFADF KPSSKPSS ERSERS Elliot (1999)Elliot (1999)
Country - ReferenceCountry - Reference lagslags t-ratiot-ratio DF-GLSDF-GLS DF-GLSDF-GLSuu
Argentina – USArgentina – US 1010 -0.421-0.421 0.389*0.389* -0.855-0.855 -0.878-0.878
Argentina – GerArgentina – Ger 1010 0.4180.418 0.411*0.411* -0.738-0.738 -0.554-0.554
Brazil – USABrazil – USA 33 -3.015*-3.015* 0.7020.702 -2.489*-2.489* -2.937*-2.937*
Brazil – GerBrazil – Ger 33 -3.119*-3.119* 0.7510.751 -2.852*-2.852* -3.077*-3.077*
Chile – USChile – US 1212 -2.054-2.054 0.179*0.179* -1.971*-1.971* -2.086-2.086
Chile – GerChile – Ger 66 -2.024-2.024 0.260*0.260* -1.587-1.587 -2.041-2.041
Mexico – USMexico – US 11 -4.593*-4.593* 0.239*0.239* -2.901*-2.901* -4.580*-4.580*
Mexico – GerMexico – Ger 11 -4.890*-4.890* 0.222*0.222* -2.690*-2.690* -4.821*-4.821*
Turkey – USTurkey – US 33 -4.230*-4.230* 0.078*0.078* -3.948*-3.948* -4.201*-4.201*
Turkey – GerTurkey – Ger 77 -3.827*-3.827* 0.067*0.067* -3.734*-3.734* -3.849*-3.849*
France – USFrance – US 1010 -2.259-2.259 0.186*0.186* -0.424-0.424 -1.783-1.783
France – GerFrance – Ger 99 -2.490-2.490 0.199*0.199* -0.845-0.845 -1.785-1.785
Italy – USItaly – US 99 -1.485-1.485 0.6880.688 -0.945-0.945 -1.312-1.312
Italy – GerItaly – Ger 99 -0.993-0.993 0.6530.653 -1.357-1.357 -1.065-1.065
Spain – USSpain – US 99 -1.759-1.759 0.6430.643 -0.349-0.349 -1.144-1.144
Spain – GerSpain – Ger 1212 -1.533-1.533 0.5270.527 -0.990-0.990 -1.233-1.233
UK – USUK – US 1010 -1.723-1.723 0.153*0.153* -0.434-0.434 -1.624-1.624
UK – GerUK – Ger 1212 -3.203*-3.203* 0.222*0.222* -0.199-0.199 -2.796*-2.796*
(US) (Ger)(US) (Ger) 77 -2.752-2.752 0.082*0.082* -0.795-0.795 -1.803-1.803
Country – ReferenceCountry – Reference LagsLags Break DateBreak Date T-ratioT-ratio
Argentina – USArgentina – US 99 2001:072001:07 -1.529-1.529
Argentina – GerArgentina – Ger 99 2001:072001:07 -1.238-1.238
Brazil – USBrazil – US 00 1995:091995:09 -5.184*-5.184*
Brazil – GerBrazil – Ger 00 1995:081995:08 -5.224*-5.224*
Chile – USChile – US 00 1998:101998:10 -5.726*-5.726*
Chile – GerChile – Ger 22 1997:101997:10 -4.837*-4.837*
Mexico – USMexico – US 11 1998:091998:09 -4.613*-4.613*
Mexico – GerMexico – Ger 11 1998:091998:09 -4.901*-4.901*
Turkey – USTurkey – US 33 1999:071999:07 -4.299*-4.299*
Turkey – GerTurkey – Ger 11 1999:071999:07 -4.984*-4.984*
France – USFrance – US 1010 1996:101996:10 -2.637-2.637
France – GerFrance – Ger 1010 2000:112000:11 -2.780-2.780
Italy – USItaly – US 1111 1996:111996:11 -4.128*-4.128*
Italy – GerItaly – Ger 99 1997:111997:11 -4.729*-4.729*
Spain – USSpain – US 99 1997:051997:05 -3.375-3.375
Spain – GerSpain – Ger 99 1997:061997:06 -4.843*-4.843*
UK – USUK – US 99 1998:031998:03 -2.871-2.871
UK – GerUK – Ger 1212 2001:092001:09 -3.824*-3.824*
(US) (Ger)(US) (Ger) 77 1996:101996:10 -3.114-3.114
10 1 1( )
p
i t i ti
t t b t t ridrid a DU D T a rid
Structural Break - Perron (1997)
Half Lives (months)Half Lives (months)Country – Country – ReferenceReference ADFADF
Structural Structural BreakBreak
Argentina – USArgentina – US 13.113.1 3.23.2
Argentina – GerArgentina – Ger ---- 3.13.1
Brazil – USABrazil – USA 3.03.0 1.21.2
Brazil – GerBrazil – Ger 2.72.7 1.21.2
Chile – USChile – US 1.11.1 0.90.9
Chile – GerChile – Ger 1.41.4 0.60.6
Mexico – USMexico – US 1.61.6 1.61.6
Mexico – GerMexico – Ger 1.51.5 1.41.4
Turkey – USTurkey – US 1.01.0 0.90.9
Turkey – GerTurkey – Ger 0.60.6 1.01.0
France – USFrance – US 1.31.3 0.80.8
France – GerFrance – Ger 1.01.0 0.60.6
Italy – USItaly – US 7.37.3 1.51.5
Italy – GerItaly – Ger 10.310.3 0.40.4
Spain – USSpain – US 5.05.0 0.80.8
Spain – GerSpain – Ger 5.65.6 1.01.0
UK – USUK – US 1.81.8 1.11.1
UK – GerUK – Ger 0.30.3 0.20.2
(US) (Ger)(US) (Ger) 1.31.3 1.01.0
ln(2)Half-life=
ln(1 )
Equilibrium Equilibrium LevelsLevels
ADFADF Structural BreakStructural Break
Country – ReferenceCountry – ReferencePeriod 1Period 1
Period 2Period 2
Argentina – USArgentina – US 2.332.33 1.48*1.48* 10.4210.42
Argentina – GerArgentina – Ger 0.820.82 1.67*1.67* 9.99.9
Brazil – USABrazil – USA 3.82*3.82* 11.10*11.10* 3.92*3.92*
Brazil – GerBrazil – Ger 3.87*3.87* 11.54*11.54* 4.12*4.12*
Chile – USChile – US 0.98**0.98** 1.05*1.05* 0.740.74
Chile – GerChile – Ger 1.12**1.12** 1.37*1.37* 1.131.13
Mexico – USMexico – US 1.37*1.37* 1.12*1.12* 1.641.64
Mexico – GerMexico – Ger 1.25*1.25* 1.35*1.35* 1.731.73
Turkey – USTurkey – US 4.44*4.44* 4.70*4.70* 4.224.22
Turkey – GerTurkey – Ger 4.95*4.95* 5.09*5.09* 4.194.19
France – USFrance – US -0.05-0.05 0.20.2 -0.08-0.08
France – GerFrance – Ger 0.10.1 0.080.08 0.250.25
Italy – USItaly – US -0.11-0.11 0.79*0.79* -0.17*-0.17*
Italy – GerItaly – Ger -0.31-0.31 1.031.03 -0.08-0.08
Spain – USSpain – US -0.31-0.31 0.53*0.53* -0.34*-0.34*
Spain – GerSpain – Ger -0.17-0.17 0.68*0.68* -0.26*-0.26*
UK – USUK – US 0.220.22 0.070.07 0.340.34
UK – GerUK – Ger 0.35*0.35* 0.340.34 0.680.68
(US) (Ger)(US) (Ger) 0.15**0.15** 00 0.190.19
0
11
a
a
M-TAR modelM-TAR model
CountryCountry ARGUSARGUS ARGERARGER BRAUSBRAUS BRAGERBRAGER CHIUSCHIUS CHGERCHGER MEXUSMEXUS MEXGERMEXGER TURUSTURUS TURGERTURGER
λλ -0.381-0.381 0.2470.247 -0.459-0.459 -0.420-0.420 -0.237-0.237 -0.502-0.502 -0.886-0.886 -0.872-0.872 -0.926-0.926 1.2901.290
mm 22 55 22 22 11 33 11 11 11 22
μμ11 -0.013-0.013(-0.055)(-0.055)
-0.177-0.177(-0.524)(-0.524)
1.6791.679(1.829)(1.829)
2.4682.468(2.572)(2.572)
1.4281.428(2.610)(2.610)
1.3581.358(2.389)(2.389)
0.6870.687(2.421)(2.421)
0.6430.643(2.237)(2.237)
3.0273.027(2.997)(2.997)
5.9565.956(3.196)(3.196)
μμ22 -0.584-0.584(-1.867)(-1.867)
-0.187-0.187(-0.515)(-0.515)
0.6960.696(0.770)(0.770)
-0.178-0.178(-0.189)(-0.189)
0.2070.207(0.325)(0.325)
0.7140.714(1.414)(1.414)
0.1940.194(0.293)(0.293)
0.5430.543(1.956)(1.956)
-2.427-2.427(-1.337)(-1.337)
0.3550.355(0.200)(0.200)
ρρ11 -0.031-0.031(-0.213)(-0.213)
0.0020.002(0.011)(0.011)
-0.472-0.472(-3.558)(-3.558)
-0.397-0.397(-3.718)(-3.718)
-0.720-0.720(-2.727)(-2.727)
-0.799-0.799(-3.168)(-3.168)
-0.341-0.341(-4.127)(-4.127)
-0.377-0.377(-4.532)(-4.532)
-0.506-0.506(-4.127)(-4.127)
-0.760-0.760(-3.946)(-3.946)
ρρ22 -0.355-0.355(2.260)(2.260)
-0.454-0.454(-1.739)(-1.739)
-0.123-0.123(-0.786)(-0.786)
0.0300.030(0.187)(0.187)
-0.304-0.304(-1.001)(-1.001)
-0.131-0.131(-0.486)(-0.486)
-0.217-0.217(-1.658)(-1.658)
-0.639-0.639(-2.211)(-2.211)
-0.402-0.402(-1.180)(-1.180)
-0.274-0.274(-1.452)(-1.452)
WWp-valuep-value
17.6417.640.0400.040
6.1286.1280.3430.343
0.8650.8650.9030.903
9.4179.4170.0230.023
5.3675.3670.4400.440
8.2108.2100.0100.010
1.561.560.7070.707
2.432.430.4870.487
21.47021.4700.0000.000
27.91227.9120.0000.000
R1R1p-valuep-value
2.9542.9540.2270.227
0.5320.5320.5870.587
9.1129.1120.0100.010
10.25610.2560.0030.003
8.6958.6950.0500.050
8.1378.1370.0230.023
22.60322.6030.0000.000
26.15426.1540.0000.000
21.1621.160.0000.000
15.86615.8660.0060.006
R2R2p-valuep-value
4.0174.0170.3600.360
1.2341.2340.7330.733
9.1399.1390.0470.047
13.85913.8590.0000.000
8.4378.4370.1330.133
7.6757.6750.0870.087
19.78319.7830.0000.000
25.42525.4250.0000.000
20.57520.5750.0030.003
15.96015.9600.0370.037
LagLag 1010 1010 33 33 1212 66 11 11 33 77
1 1
' '1 1 2 1
1
1 1t t
p
t t t j t j tz zj
y y y rid
M-TAR model (cont.)M-TAR model (cont.)
CountryCountry FRAUSFRAUS FRAGERFRAGER ITAUSITAUS ITAGERITAGER SPAUSSPAUS SPAGERSPAGER UKUSUKUS UKGERUKGER USGERUSGER
λλ 0.2640.264 0.3990.399 -0.087-0.087 0.3470.347 0.0300.030 -0.220-0.220 -1.110-1.110 0.8010.801 0.5060.506
mm 66 55 44 55 22 66 33 11 11
μμ11 0.6270.627(2.381)(2.381)
0.0040.004(0.020)(0.020)
0.0260.026(0.153)(0.153)
-0.453-0.453(-1.416)(-1.416)
0.1000.100(0.615)(0.615)
0.0440.044(0.264))(0.264))
-0.025-0.025(-0.191)(-0.191)
-0.818-0.818(-0.917)(-0.917)
0.5100.510(2.433)(2.433)
μμ22 -0.221-0.221(-1.659)(-1.659)
0.1770.177(1.482)(1.482)
-0.048-0.048(-0.279)(-0.279)
0.2900.290(1.455)(1.455)
-0.448-0.448(-3.029)(-3.029)
-0.230-0.230(-1.145)(-1.145)
-0.441-0.441(-0.964)(-0.964)
0.3280.328(2.774)(2.774)
0.0190.019(0.262)(0.262)
ρρ11 -0.278-0.278(-1.198)(-1.198)
-0.566-0.566(-2.699)(-2.699)
-0.124-0.124(-0.945)(-0.945)
-0.005-0.005(-0.031)(-0.031)
-0.126-0.126(-0.834)(-0.834)
-0.092-0.092(-0.688))(-0.688))
-0.388-0.388(-1.482)(-1.482)
-0.313-0.313(-0.444)(-0.444)
-0.379-0.379(-1.798)(-1.798)
ρρ22 -0.382-0.382(-1.757)(-1.757)
-0.472-0.472(-2.139)(-2.139)
-0.041-0.041(-0.273)(-0.273)
-0.204-0.204(-1.502)(-1.502)
0.0740.074(0.515)(0.515)
-0.044-0.044(-0.242)(-0.242)
-0.795-0.795(-2.202)(-2.202)
-0.903-0.903(-3.235)(-3.235)
-0.549-0.549(-3.671)(-3.671)
WWp-valuep-value
5.9415.9410.3570.357
16.98416.9840.0400.040
15.67915.6790.0160.016
8.6318.6310.1830.183
13.50413.5040.0570.057
4.7744.7740.4330.433
0.7270.7270.9470.947
5.5975.5970.4370.437
20.42020.4200.0060.006
R1R1p-valuep-value
7.7107.7100.0600.060
7.9777.9770.0430.043
0.8230.8230.5230.523
0.8230.8230.4160.416
0.1350.1350.7830.783
1.081.080.4230.423
5.4325.4320.0900.090
16.75416.7540.0000.000
10.10510.1050.0100.010
R2R2p-valuep-value
7.1057.1050.1770.177
3.8713.8710.3530.353
0.9680.9680.7900.790
1.8921.8920.5830.583
0.8040.8040.7730.773
0.7340.7340.8460.846
6.0276.0270.2170.217
10.78210.7820.0930.093
16.09816.0980.0100.010
LagLag 1010 1010 99 99 99 1212 1111 1212 77
• Equilibrium is statistically different from zero in most countries.
- Permanent rids - The long run mean of
developing economies is higher than developed countries.
ConclusionsConclusions
Next Chapters:
What are the Causes?
Evidence Supporting RIPH Evidence Against RIPH
• Rids tend to be short lived if structural breaks are taken into account.
- Foreign financial crises seem to have impacted rids of emerging markets.
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