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Mean reversion of short-run interest rates in emerging countries.

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Disciplines
  • Economics
  • Mathematics

Abstract

Mean Reversion of Short-run Interest Rates in Emerging Countries* Mean Reversion of Short-run Interest Rates in Emerging Countries* Bertrand Candelon and Luis A. Gil-Alana Abstract In this paper we examine the stochastic behavior of short-run interest rates in several emerging countries using fractional integration techniques. We allow for a much richer flexibility in the dynamic behavior of the series than the classical representations based on I(0) or I(1) processes. It appears that for Singapore and Thailand nominal interest rates are mean-reverting, whereas for Mexico, Malaysia, the Philippines, and Korea, the presence of a unit-root test depends on the assumptions regarding the residuals’ autocorre- lation. The results also suggest that uncovered interest parity (UIP) can only hold for two emerging countries. For the other countries, the stabilization policies in the aftermath of the currency crises have led to the rejection of the UIP hypothesis. 1. Introduction The analysis of interest rate persistence is a major question in the empirical literature. Rose (1988), Stock and Watson (1988), Campbell and Shiller (1991), and Wu and Chen (2001) have applied a number of unit-root tests to determine whether short-run inter- est rates are stationary or not. The mean-reverting property of the series has major consequences. First, in terms of modeling strategies, it turns out that vector-error cor- rection (VEC) or vector autoregression (VAR) in differences are not necessary to model the dynamics of short-run interest rates. A simple VAR in levels appears suffi- cient to represent the dynamics of short-run interest rates. Secondly, the rejection of a unit-root test in short-run interest rates sheds some light on the empirical investiga- tion of two major relationships in macroeconomics: the Fisher hypothesis (FH) and the uncovered interest parity hypothesis (UIP). If interest rates and inflation are found to be nonstationary (or I(1)), a long-run version of the FH can be tested withi

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