Estimating Parameters of Short-Term Real Interest Rate Models

October 17, 2013

Preview Citation

Format: Chicago

Vadim Khramov. Estimating Parameters of Short-Term Real Interest Rate Models, (USA: International Monetary Fund, 2013) accessed November 23, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper sheds light on a narrow but crucial question in finance: What should be the parameters of a model of the short-term real interest rate? Although models for the nominal interest rate are well studied and estimated, dynamics of the real interest rate are rarely explored. Simple ad hoc processes for the short-term real interest rate are usually assumed as building blocks for more sophisticated models. In this paper, parameters of the real interest rate model are estimated in the broad class of single-factor interest rate diffusion processes on U.S. monthly data. It is shown that the elasticity of interest rate volatility—the relationship between the volatility of changes in the interest rate and its level—plays a crucial role in explaining real interest rate dynamics. The empirical estimates of the elasticity of the real interest rate volatility are found to be about 0.5, much lower than that of the nominal interest rate. These estimates show that the square root process, as in the Cox-Ingersoll-Ross model, provides a good characterization of the short-term real interest rate process.

Subject: Financial services, Inflation, Interest rate modelling, Prices, Real interest rates, Short term interest rates, Yield curve

Keywords: Data series, Diffusion process, Inflation, Inflation expectation, Interest rate modelling, Nominal interest rate, Nominal interest rate model, Real interest rate, Real interest rate model, Real interest rate process, Real interest rates, Short term interest rates, Short-term Interest Rate, Single-factor Models, WP, Yield curve

Publication Details

Pages:

27
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2013/212
Stock No:

WPIEA2013212
ISBN:

9781475594645
ISSN:

1018-5941

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