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An Empirical Investigation of the Level Effect in Australian Interest Rates

Author

Listed:
  • Philip Gray

    (UQ Business School, University of Queensland, St Lucia 4072.)

  • Daniel R. Smith

    (Faculty of Business Administration, Simon Fruser University, 8888 University Drive, Burnaby BC V5A 1S6, Canada.)

Abstract

An extensive literature examines the dynamics of interest rates, with particular attention given to the positive relationship between interest-rate volatility and the level of interest rates—the so-called level effect. This paper examines the interaction between the estimated level effect and competing parameterisations of interest-rate volatility for the Australian yield curve. We adopt a new methodology that estimates elasticity in a multivariate setting that explicitly accommodates the correlations that exist between various yield factors. Results show that significant correlations exist between the residuals of yield factors and that such correlations do indeed impact on model estimates. Within the multivariate setting, the level of the short rate is shown to be a crucial determinant of the conditional volatility of all three yield factors. Measures of model fit suggest that, in addition to the usual level effect, the incorporation of GARCH effects and possible regime shifts is important.

Suggested Citation

  • Philip Gray & Daniel R. Smith, 2008. "An Empirical Investigation of the Level Effect in Australian Interest Rates," Australian Journal of Management, Australian School of Business, vol. 33(1), pages 31-45, June.
    • Handle: RePEc:sae:ausman:v:33:y:2008:i:1:p:31-45
    DOI: 10.1177/031289620803300103
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    References listed on IDEAS

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    Cited by:

    1. Vijay A. Murik, 2013. "Bond pricing with a surface of zero coupon yields," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(2), pages 497-512, June.
    2. Robert E. Marks, 2008. "The Subprime Mortgage Meltdown," Australian Journal of Management, Australian School of Business, vol. 33(1), pages 0-6, June.
    3. Vijay A Murik, 2013. "Measuring monetary policy expectations," Australian Journal of Management, Australian School of Business, vol. 38(1), pages 49-65, April.

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