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Interest Rate Dynamics and Interest Rate Targeting

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  • Guthrie, Graeme
  • Wright, Julian

Abstract

This paper derives the dynamic properties of interest rates at the short end of the yield curve using a model of central bank interest rate targeting. The model predicts that conditional volatility is persistent and increasing in the spread between the market rate and the central bank’s target rate, that there is excess kurtosis in high frequency interest rate movements, and that market rates will revert towards the central bank’s target rate. We show these effects are present in a sample of recent daily data on U.S. interest rates. The results suggest that the spread between market rates and the central bank’s target rate should be considered in empirical models of interest rate dynamics.

Suggested Citation

  • Guthrie, Graeme & Wright, Julian, 2002. "Interest Rate Dynamics and Interest Rate Targeting," Working Paper Series 33484, Victoria University of Wellington, School of Economics and Finance.
    • Handle: RePEc:vuw:vuwecf:33484
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    File URL: https://ir.wgtn.ac.nz/handle/123456789/33484
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    References listed on IDEAS

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    1. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 245-274, April.
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    3. Chan, K C, et al, 1992. "An Empirical Comparison of Alternative Models of the Short-Term Interest Rate," Journal of Finance, American Finance Association, vol. 47(3), pages 1209-1227, July.
    4. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    5. Stanton, Richard, 1997. "A Nonparametric Model of Term Structure Dynamics and the Market Price of Interest Rate Risk," Journal of Finance, American Finance Association, vol. 52(5), pages 1973-2002, December.
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