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Real Interest Rates and Inflation: An Ex-Ante Empirical Analysis

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  • Shmuel Kandel
  • Aharon R. Ofer
  • Oded Sarig

Abstract

We develop a method of measuring ex-ante real interest rate using prices of index and nominal bonds. Employing this method and newly available data, we directly test the Fisher hypothesis that the real rate of interest is independent of inflation expectations. We find a negative correlation between ex-ante real interest rates and expected inflation. This contradicts the Fisher hypothesis but is consistent with the theories of Mundell and Tobin, Darby and Feldstein, and Stulz. We also find that nominal interest rates include an inflation risk premium that is positively related to a proxy for inflation uncertainty.

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Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 2-95.

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Handle: RePEc:fth:pennfi:2-95

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Cited by:
  1. Azoulay, Eddy & Brenner, Menachem & Landskroner, Yoram & Stein, Roy, 2014. "Inflation risk premium implied by options," Journal of Economics and Business, Elsevier, vol. 71(C), pages 90-102.
  2. Fletcher, Donna J. & Gulley, O. David, 1996. "Forecasting the real interest rate," The North American Journal of Economics and Finance, Elsevier, vol. 7(1), pages 55-76.
  3. Kasimir Kaliva, 2008. "The Fisher effect, survey data and time-varying volatility," Empirical Economics, Springer, vol. 35(1), pages 1-10, August.
  4. Juan Angel Garcia & Adrian van Rixtel, 2007. "Inflation-linked bonds from a Central Bank perspective," Occasional Paper Series 62, European Central Bank.
  5. Malliaropulos, Dimitrios, 2000. "A note on nonstationarity, structural breaks, and the Fisher effect," Journal of Banking & Finance, Elsevier, vol. 24(5), pages 695-707, May.
  6. Anderson, Hamish D. & Malone, Christopher B. & Marshall, Ben R., 2008. "Investment returns under right- and left-wing governments in Australasia," Pacific-Basin Finance Journal, Elsevier, vol. 16(3), pages 252-267, June.
  7. Rokon Bhuiyan, 2013. "Inflationary expectations and monetary policy: evidence from Bangladesh," Empirical Economics, Springer, vol. 44(3), pages 1155-1169, June.
  8. Ayelet Balsam & Shmuel Kandel & Ori Levy, . "Ex-Ante Real Rates and Inflation Risk Premiums: A Consumption-Based Approach," Rodney L. White Center for Financial Research Working Papers 22-98, Wharton School Rodney L. White Center for Financial Research.
  9. Marco Espinosa-Vega & Steven Russell, 1998. "The long-run real effects of monetary policy: Keynesian predictions from a neoclassical model," Working Paper 98-6, Federal Reserve Bank of Atlanta.
  10. Thomas C. Melzer, 1997. "To conclude: keep inflation low and, in principle, eliminate it," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 3-7.
  11. Peter Hoerdahl & Oreste Tristani, 2007. "Inflation risk premia in the term structure of interest rates," BIS Working Papers 228, Bank for International Settlements.
  12. Mark M. Spiegel, 1998. "Central bank independence and inflation expectations: evidence from British index-linked gilts," Economic Review, Federal Reserve Bank of San Francisco, pages 3-14.
  13. Francis Breedon & Jag Chadha, 1997. "The Information Content of the Inflation Term Structure," Bank of England working papers 75, Bank of England.
  14. J. Benson Durham, 2006. "An estimate of the inflation risk premium using a three-factor affine term structure model," Finance and Economics Discussion Series 2006-42, Board of Governors of the Federal Reserve System (U.S.).
  15. Noor Ghazali & Shamshubariah Ramlee, 2003. "A long memory test of the long-run Fisher effect in the G7 countries," Applied Financial Economics, Taylor & Francis Journals, vol. 13(10), pages 763-769.
  16. Laatsch, Francis E. & Klein, Daniel P., 2003. "Nominal rates, real rates, and expected inflation: Results from a study of U.S. Treasury Inflation-Protected Securities," The Quarterly Review of Economics and Finance, Elsevier, vol. 43(3), pages 405-417.
  17. Reschreiter, Andreas, 2004. "Conditional funding costs of inflation-indexed and conventional government bonds," Journal of Banking & Finance, Elsevier, vol. 28(6), pages 1299-1318, June.
  18. George M. von Furstenberg & Michael T. Gapen, 1998. "Conditional Indexation Bias in Yields Reported on Inflation-Indexed Securities with Special Reference to UDIBONOS and TIPS," Economia Mexicana NUEVA EPOCA, , vol. 0(2), pages 149-188, July-Dece.

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