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Uncertainty and the price of risk in a nominal convergence process

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Author Info

  • Ricardo Gimeno

    ()
    (Banco de España)

  • José Manuel Marqués

    ()
    (Banco de España)

Abstract

In this paper we decompose nominal interest rates into real risk-free rates, inflation expectations and risk premia using an affine model that takes as factors the observed inflation rate and the parameters generated in the zero yield curve estimation. We apply this model to the Spanish economy during the 90s, which is an especially challenging exercise given the nominal convergence towards the European Monetary Union (EMU) then under way. The methodology seems to be suitable for other countries currently involved in convergence towards EMU. The evidence indicates that inflation expectations and risk premia account for most of the observed variation in nominal rates, while real risk-free interest rates show a reduction during this period lower than that suggested by other approaches.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/08/Fic/dt0802e.pdf
File Function: First version, January 2008
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Bibliographic Info

Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 0802.

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Length: 39 pages
Date of creation: Jan 2008
Date of revision:
Handle: RePEc:bde:wpaper:0802

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Related research

Keywords: Real interest rates; Risk Premium; Inflation expectations; Affine Model;

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Cited by:
  1. Ricardo Gimeno & José Manuel Marqués, 2009. "Extraction of financial market expectations about inflation and interest rates from a liquid market," Banco de Espa�a Working Papers 0906, Banco de Espa�a.
  2. Mencía, Javier, 2012. "Assessing the risk-return trade-off in loan portfolios," Journal of Banking & Finance, Elsevier, vol. 36(6), pages 1665-1677.

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