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Explaining European Short-term Interest Rate Differentials: An Application of Tobin's Portfolio Theory

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Author Info
Thomas J. Flavin () (Economics, National University of Ireland, Maynooth)
Michele G. Limosani (Economics, Universita di Messina, Italy.)

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Abstract

This paper seeks to identify potential determinants of short interest rate differentials across European countries. We rely on the portfolio theory of Tobin to choose our set of risk factors and then assess the ability of these macroeconomic variables to influence both the conditional mean and volatility of interest rate differentials. The macroeconomic variables employed in the analysis may be loosely considered to reflect both domestic government fiscal and monetary policy and international influences.We find significant ARCH-in-mean effects, implying that the conditional volatility of the interest rate differential exerts an important influence in the determination of its mean value. There are also significant short-run contagion effects whereby volatility in the macroeconomic factors is transmitted to the overall riskiness of the differential which in turn impacts upon the level of the differential.

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Publisher Info
Paper provided by Department of Economics, Finance and Accounting, National University of Ireland - Maynooth in its series Economics, Finance and Accounting Department Working Paper Series with number n1000500.

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Length: 18 pages
Date of creation: May 2000
Date of revision:
Handle: RePEc:may:mayecw:n1000500

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Postal: Maynooth, Co. Kildare
Phone: 353-1-7083728
Fax: 353-1-7083934
Web page: http://www.may.ie/academic/economics/
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Related research
Keywords: Interest rate differentials risk premium multivariate ARCH

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Find related papers by JEL classification:
F3 - International Economics - - International Finance
G1 - Financial Economics - - General Financial Markets

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References listed on IDEAS
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  1. James Tobin, 1956. "Liquidity Preference as Behavior Towards Risk," Cowles Foundation Discussion Papers 14, Cowles Foundation, Yale University. [Downloadable!]
  2. Flavin, T J & Limosani, M G, 2000. "Fiscal Policy and the Term Premium in Real Interest Rate Differentials," Applied Financial Economics, Taylor and Francis Journals, vol. 10(4), pages 413-17, August. [Downloadable!] (restricted)
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  3. Thomas J. Flavin & Michael R. Wickens, 1998. ": A Risk Management Approach to Optimal Asset Allocation," Economics, Finance and Accounting Department Working Paper Series n851298, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth. [Downloadable!]
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  4. repec:cup:etheor:v:11:y:1995:i:1:p:122-50 is not listed on IDEAS
  5. Frankel, Jeffrey A. & MacArthur, Alan T., 1988. "Political vs. currency premia in international real interest differentials : A study of forward rates for 24 countries," European Economic Review, Elsevier, vol. 32(5), pages 1083-1114, June. [Downloadable!] (restricted)
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  6. Tobin, James, 1982. "Money and Finance in the Macroeconomic Process," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 14(2), pages 171-204, May. [Downloadable!] (restricted)
    Other versions:
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