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On real interest rate dynamics and regime switching

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  • Kanas, Angelos
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    Abstract

    We find evidence of regime switching dynamics in the USA and the UK real interest rates over the period 1881-2003. For the UK, there is a regime in which the real interest rate displays a relatively stronger mean-reversion and a regime in which it displays a relatively weaker mean-reversion. The former regime is characterized by a relatively larger error in the estimation of the reversion parameter, and higher volatility. For the USA, the two regimes differ in volatility. The probability of transition from one regime to another is found to be significantly related to the inflation rate regime, and to the political regime. The results highlight the importance of regime switching in the dynamics of the real interest rate, as well as the role of inflation and political regimes in explaining this switching.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 32 (2008)
    Issue (Month): 10 (October)
    Pages: 2089-2098

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    Handle: RePEc:eee:jbfina:v:32:y:2008:i:10:p:2089-2098

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    Web page: http://www.elsevier.com/locate/jbf

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    Keywords: Real interest rate Inflation regimes Political regimes USA UK;

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    Cited by:
    1. Chevallier, Julien, 2012. "Global imbalances, cross-market linkages, and the financial crisis : a multivariate Markov-Switching analysis," Economics Papers from University Paris Dauphine 123456789/8773, Paris Dauphine University.
    2. Joyce, Michael A.S. & Lildholdt, Peter & Sorensen, Steffen, 2010. "Extracting inflation expectations and inflation risk premia from the term structure: A joint model of the UK nominal and real yield curves," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(2), pages 281-294, February.
    3. K. Zhang & K. Teo & M. Swartz, 2014. "A Robust Numerical Scheme For Pricing American Options Under Regime Switching Based On Penalty Method," Computational Economics, Society for Computational Economics, Society for Computational Economics, vol. 43(4), pages 463-483, April.
    4. repec:wyi:journl:002118 is not listed on IDEAS
    5. Kuang-Liang Chang, 2012. "Stock return predictability and stationarity of dividend yield," Economics Bulletin, AccessEcon, vol. 32(1), pages 715-729.
    6. Lee, Bong Soo, 2010. "Stock returns and inflation revisited: An evaluation of the inflation illusion hypothesis," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(6), pages 1257-1273, June.
    7. Hong, Yongmiao & Lin, Hai & Wang, Shouyang, 2010. "Modeling the dynamics of Chinese spot interest rates," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(5), pages 1047-1061, May.
    8. Lee, Sangwook & Kim, Min Jae & Kim, Soo Yong, 2011. "Interest rates factor model," Physica A: Statistical Mechanics and its Applications, Elsevier, Elsevier, vol. 390(13), pages 2531-2548.
    9. Powell, John G. & Shi, Jing & Smith, Tom & Whaley, Robert E., 2009. "Political regimes, business cycles, seasonalities, and returns," Journal of Banking & Finance, Elsevier, Elsevier, vol. 33(6), pages 1112-1128, June.
    10. Chang, Kuang-Liang, 2012. "Volatility regimes, asymmetric basis effects and forecasting performance: An empirical investigation of the WTI crude oil futures market," Energy Economics, Elsevier, Elsevier, vol. 34(1), pages 294-306.

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