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Mean Reversion in the Real Interest Rate and the Effects of Calculating Expected Inflation

  • Onsurang Norrbin


    (Department of Economics, Florida State University, 288 Bellamy Building, Tallahassee, FL 32306, USA)

  • Aaron D. Smallwood


    (Department of Economics, University of Texas at Arlington, 701 South West Street Box 19479, Arlington, TX 76019, USA)

We investigate the measured persistence in the real interest rate using a variety of methods to annualize inflation and calculate the real rate. Results from a battery of conventional unit root tests yield conflicting conclusions for the various real rates, adding to an existing confusion regarding mean reversion. Both long memory and exponential smooth-transition autoregressive models (ESTAR) nonlinearity are considered as possible alternatives, and in contrast to the unit root test results, we find highly robust evidence against the unit root null. Based on the empirical results, Monte Carlo analysis is performed to study the disparate results obtained using fractional integration and unit root tests.

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Article provided by Southern Economic Association in its journal Southern Economic Journal.

Volume (Year): 78 (2011)
Issue (Month): 1 (July)
Pages: 107-130

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Handle: RePEc:sej:ancoec:v:78:1:y:2011:p:107-130
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