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Uncertainty and the price of risk in a nominal convergence process

Author

Listed:
  • Ricardo Gimeno

    () (Banco de España)

  • José Manuel Marqués

    () (Banco de España)

Abstract

In this paper we decompose nominal interest rates into real risk-free rates, inflation expectations and risk premia using an affine model that takes as factors the observed inflation rate and the parameters generated in the zero yield curve estimation. We apply this model to the Spanish economy during the 90s, which is an especially challenging exercise given the nominal convergence towards the European Monetary Union (EMU) then under way. The methodology seems to be suitable for other countries currently involved in convergence towards EMU. The evidence indicates that inflation expectations and risk premia account for most of the observed variation in nominal rates, while real risk-free interest rates show a reduction during this period lower than that suggested by other approaches.

Suggested Citation

  • Ricardo Gimeno & José Manuel Marqués, 2008. "Uncertainty and the price of risk in a nominal convergence process," Working Papers 0802, Banco de España;Working Papers Homepage.
  • Handle: RePEc:bde:wpaper:0802
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    File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/08/Fic/dt0802e.pdf
    File Function: First version, January 2008
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    Citations

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    Cited by:

    1. Rocío Elizondo, 2013. "Forecasting the Term Structure of Interest Rates in Mexico Using an Affine Model," Working Papers 2013-03, Banco de México.
    2. Mencía, Javier, 2012. "Assessing the risk-return trade-off in loan portfolios," Journal of Banking & Finance, Elsevier, vol. 36(6), pages 1665-1677.
    3. Ricardo Gimeno & José Manuel Marqués, 2009. "Extraction of financial market expectations about inflation and interest rates from a liquid market," Working Papers 0906, Banco de España;Working Papers Homepage.

    More about this item

    Keywords

    Real interest rates; Risk Premium; Inflation expectations; Affine Model;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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