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What is driving the Capital Inflows to Costa Rica? Risk Premium and Interest Rate Differentials

Author

Listed:
  • Leon, Jorge
  • Vega, Melissa

Abstract

The goal of this paper is to analyse the interest rate differential as the possible main factor behind the capital inflows experienced by Costa Rica during the second semester of 2012. For this purpose, a panel data model for interest rate differential is estimated taking into consideration an array of relevant macroeconomic variables. The results suggest that interest rate differentials for Costa Rica in 2012 are above what the estimated model predicts for the lending rate and deposit rate by 8.4 pp., and between 2.7 p.p. and 1.7 p.p., respectively. This excess in the interest rate differential could explain the observed capital inflows. Therefore, a reduction of lending and deposit interest rate differentials is crucial, but an extra effort has to be made to reduce the lending rate differential. As a consequence of the prevailing situation, the difference between lending and deposit rate in Costa Rica is greater than in countries with similar levels of risk.

Suggested Citation

  • Leon, Jorge & Vega, Melissa, 2013. "What is driving the Capital Inflows to Costa Rica? Risk Premium and Interest Rate Differentials," MPRA Paper 59215, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:59215
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    References listed on IDEAS

    as
    1. Peter Rowland, 2004. "Determinants Of Spread , Credit Rating And Creditworthiness For Emerging Market Sovereign Debt: A Panel Data Study," Borradores de Economia 2336, Banco de la Republica.
    2. Peter Rowland, 2004. "The Colombian Sovereign Spread and its Determinants," Borradores de Economia 315, Banco de la Republica de Colombia.
    3. 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.
    4. Peter Rowland & José Luis Torres, 2004. "Determinants of Spread and Creditworthiness for Emerging Market Sovereign Debt:A Panel Data Study," Borradores de Economia 295, Banco de la Republica de Colombia.
    5. Leon, Jorge, 2013. "Capital Inflows in a Small Open Economy: Costa Rica," MPRA Paper 44512, University Library of Munich, Germany, revised 2013.
    6. Aliber, Robert Z, 1973. "The Interest Rate Parity Theorem: A Reinterpretation," Journal of Political Economy, University of Chicago Press, vol. 81(6), pages 1451-1459, Nov.-Dec..
    7. Peter Rowland, 2004. "The Colombian Sovereign Spread And Its Determinants," Borradores de Economia 3572, Banco de la Republica.
    8. Peter Rowland, 2004. "Determinants of Spread and Credit Ratings and Creditworthiness for Emerging Market Sovereign Debt: A Follow-Up Study Using Pooled Data Analysis," Borradores de Economia 296, Banco de la Republica de Colombia.
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    More about this item

    Keywords

    Interest Rate; Risk Premium; Uncovered Interest Rate Parity;
    All these keywords.

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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