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Are Real Interest Differentials Caused by Frictions in Goods or Assets Markets, Real or Nominal Shocks?

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Author Info
Alex Luiz Ferreira ()

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Abstract

The variance of real interest rate differentials (rids) is decomposed between ex post deviations from relative purchasing power parity and uncovered interest rate parity (UIRP) for a set of emerging markets from 1995M5 to 2004M3. The results point out to nominal interest rate differentials and ex post deviations from UIRP as the main source of volatility in rids. In order to uncover the dynamic effects of real and monetary disturbances, I estimated a bivariate VAR with rids and nominal interest rate differentials. Forecast error variance decomposition using short run restrictions on the VAR strongly supports the claim that money shocks are unable to explain the variability of rids at longer horizons. Long-run restrictions results in real shocks as the likely cause of rids. Analysis of impulse response functions demonstrates that the net impact of a (one standard deviation) real shock on rids after 36 months is large.

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File URL: ftp://ftp.ukc.ac.uk/pub/ejr/RePEc/ukc/ukcedp/0407.pdf
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Paper provided by Department of Economics, University of Kent in its series Studies in Economics with number 0407.

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Date of creation: Aug 2004
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Handle: RePEc:ukc:ukcedp:0407

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Postal: Department of Economics, University of Kent at Canterbury, Canterbury, Kent, CT2 7NP
Phone: +44 (0)1227 764000
Fax: +44 (0)1227 827850
Web page: http://www.ukc.ac.uk/economics/

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Related research
Keywords: Real Interest Rate Parity Exchange Rates Variance Decomposition VAR (Vector Autoregression)

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Find related papers by JEL classification:
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements

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References listed on IDEAS
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    Other versions:
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  22. Ronald MacDonald & Jun Nagayasu, 2000. "The Long-Run Relationship Between Real Exchange Rates and Real Interest Rate Differentials: A Panel Study," IMF Staff Papers, Palgrave Macmillan Journals, vol. 47(1), pages 5. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Alex Luiz Ferreira, 2004. "Leaning Against the Parity," Studies in Economics 0413, Department of Economics, University of Kent. [Downloadable!]
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