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Explaining European Short-term Interest Rate Differentials: An Application of Tobin's Portfolio Theory

  • Thomas J. Flavin

    ()

    (Economics, National University of Ireland, Maynooth)

  • Michele G. Limosani

    (Economics, Universita di Messina, Italy.)

This paper seeks to identify potential determinants of short interest rate differentials across European countries. We rely on the portfolio theory of Tobin to choose our set of risk factors and then assess the ability of these macroeconomic variables to influence both the conditional mean and volatility of interest rate differentials. The macroeconomic variables employed in the analysis may be loosely considered to reflect both domestic government fiscal and monetary policy and international influences.We find significant ARCH-in-mean effects, implying that the conditional volatility of the interest rate differential exerts an important influence in the determination of its mean value. There are also significant short-run contagion effects whereby volatility in the macroeconomic factors is transmitted to the overall riskiness of the differential which in turn impacts upon the level of the differential.

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Paper provided by Department of Economics, Finance and Accounting, National University of Ireland - Maynooth in its series Economics, Finance and Accounting Department Working Paper Series with number n1000500.

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Length: 18 pages
Date of creation: May 2000
Date of revision:
Handle: RePEc:may:mayecw:n1000500
Contact details of provider: Postal: Maynooth, Co. Kildare
Phone: 353-1-7083728
Fax: 353-1-7083934
Web page: http://www.maynoothuniversity.ie/economics-finance-and-accounting

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  1. Jeffrey A. Frankel and Alan T. MacArthur., 1987. "Political vs. Currency Premia in International Real Interest Differentials: A Study of Forward Rates for 24 Countries," Economics Working Papers 8762, University of California at Berkeley.
  2. repec:cup:etheor:v:11:y:1995:i:1:p:122-50 is not listed on IDEAS
  3. James Tobin, 1982. "Money and Finance in the Macro-Economic Process," Cowles Foundation Discussion Papers 613R, Cowles Foundation for Research in Economics, Yale University.
  4. Thomas J. Flavin & Michael R. Wickens, 1998. ": A Risk Management Approach to Optimal Asset Allocation," Economics, Finance and Accounting Department Working Paper Series n851298, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
  5. Thomas J. Flavin & Michele G. Limosani, 1998. "Fiscal Policy and the Term Premium in Real Interest Rate Differentials," Economics, Finance and Accounting Department Working Paper Series n830498, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
  6. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(01), pages 122-150, February.
  7. James Tobin, 1956. "Liquidity Preference as Behavior Towards Risk," Cowles Foundation Discussion Papers 14, Cowles Foundation for Research in Economics, Yale University.
  8. Bollerslev, Tim & Engle, Robert F. & Nelson, Daniel B., 1986. "Arch models," Handbook of Econometrics, in: R. F. Engle & D. McFadden (ed.), Handbook of Econometrics, edition 1, volume 4, chapter 49, pages 2959-3038 Elsevier.
  9. Michele Limosani, 2000. "What Explains Real Interest Rate Differentials across European Countries?," STUDI ECONOMICI, FrancoAngeli Editore, vol. 2000(71).
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