Interest rate determination in the interbank market

The purpose of this paper is to study the determinants of equilibrium in the market for daily funds. We use the EONIA panel database which includes daily information on the lending rates applied by contributing commercial banks. The data clearly shows an increase in both the time series volatility and the cross section dispersion of rates towards the end of the reserve maintenance period. These increases are highly correlated. With respect to quantities, we find that the volume of trade as well as the use of the standing facilities are also larger at the end of the maintenance period. Our theoretical model shows how the operational framework of monetary policy causes a reduction in the elasticity of the supply of funds by banks throughout the reserve maintenance period. This reduction in the elasticity together with market segmentation and heterogeneity are able to generate distributions for the interest rates and quantities traded with the same properties as in the data.

New evidence of the real interest rate parity for OECD countries using panel unit root tests with breaks

This paper tests for real interest parity (RIRP) among the nineteen major OECD countries over the period 1978:Q2-1998:Q4. The econometric methods applied consist of combining the use of several unit root or stationarity tests designed for panels valid under cross-section dependence and presence of multiple structural breaks. Our results strongly support the fulfillment of the weak version of the RIRP for the studied period once dependence and structural breaks are accounted for.

The choice of banking firm: Are the interest rate a significant criteria?

The objective of the research is to know the factors that in Spain determine the choice of banking organization. The obtained results indicate that the dimension of the network of branches is the reason more valued. In spite of the increasing symmetry of the Spanish banking market, the preferences of the clients of the savings banks and those of the banks are not absolutely coincident, being the proximity - the main reason for election- much more valued by the former than by the latter. The existence of divergences in the preferences has also been detected according to the region and the typology of city of residence.

How did the Financial Crisis affect the Real Interest Rate Dynamics in Europe?

We investigate the effects of the financial crisis on the stationarity of real interest rates in the Euro Area. We use a new unit root test developed by Peseran et al. (2013) that allows for multiple unobserved factors in a panel set up. Our results suggest that while short-term and long-term real interest rates were stationary before the financial crisis, they became nonstationary during the crisis period likely due to persistent risk that characterized financial markets during that time. JEL codes: E43, C23. Keywords: Real interest rates, Euro Area, financial crisis, panel unit root tests, cross-sectional dependence.

Option pricing under stochastic volatility and stochastic interest rate in the Spanish case

Among the underlying assumptions of the Black-Scholes option pricingmodel, those of a fixed volatility of the underlying asset and of aconstantshort-term riskless interest rate, cause the largest empirical biases. Onlyrecently has attention been paid to the simultaneous effects of thestochasticnature of both variables on the pricing of options. This paper has tried toestimate the effects of a stochastic volatility and a stochastic interestrate inthe Spanish option market. A discrete approach was used. Symmetricand asymmetricGARCH models were tried. The presence of in-the-mean and seasonalityeffectswas allowed. The stochastic processes of the MIBOR90, a Spanishshort-terminterest rate, from March 19, 1990 to May 31, 1994 and of the volatilityofthe returns of the most important Spanish stock index (IBEX-35) fromOctober1, 1987 to January 20, 1994, were estimated. These estimators wereused onpricing Call options on the stock index, from November 30, 1993 to May30, 1994.Hull-White and Amin-Ng pricing formulas were used. These prices werecomparedwith actual prices and with those derived from the Black-Scholesformula,trying to detect the biases reported previously in the literature. Whereasthe conditional variance of the MIBOR90 interest rate seemed to be freeofARCH effects, an asymmetric GARCH with in-the-mean and seasonalityeffectsand some evidence of persistence in variance (IEGARCH(1,2)-M-S) wasfoundto be the model that best represent the behavior of the stochasticvolatilityof the IBEX-35 stock returns. All the biases reported previously in theliterature were found. All the formulas overpriced the options inNear-the-Moneycase and underpriced the options otherwise. Furthermore, in most optiontrading, Black-Scholes overpriced the options and, because of thetime-to-maturityeffect, implied volatility computed from the Black-Scholes formula,underestimatedthe actual volatility.

The impact of interest-rate subsidies on long-term household debt: Evidence from a large program

The responsiveness of long-term household debt to the interest rate is acrucial parameter for assessing the effectiveness of public policies aimedat promoting specific types of saving. This paper estimates the effect ofa reform of Credito Bonificado, a large program in Portugal that subsidizedmortgage interest rates, on long-term household debt. The reform establisheda ceiling in the price of the house that could be financed through theprogram, and provides plausibly exogenous variation in incentives. Usinga unique dataset of matched household survey data and administrative recordsof debt, we document a large decrease in the probability of signing a newloan after the removal of the subsidy.

Interest rate restrictions in a natural experiment: loan allocation and the change in the usury laws in 1714

This article studies the effects of interest rate restrictions on loan allocation. The British governmenttightened the usury laws in 1714, reducing the maximum permissible interest rate from 6% to5%. A sample of individual loan transactions reveals that average loan size and minimum loan sizeincreased strongly, while access to credit worsened for those with little social capital. Collateralisedcredits, which had accounted for a declining share of total lending, returned to their former role ofprominence. Our results suggest that the usury laws distorted credit markets significantly; we findno evidence that they offered a form of Pareto-improving social insurance.

Constant interest rate projections without the curse of indeterminacy

Constant interest rate (CIR) projections are often criticized on the grounds that they are inconsistent with the existence of a unique equilibrium in a variety of forward-looking models. This note shows howto construct CIR projections that are not subject to that criticism, using a standard New Keynesian model as a reference framework.

On the timing of balance of payments crises: Disaggregated information and interest rate policy

This paper proposes a dynamic framework to study the timing of balance of paymentscrises. The model incorporates two main ingredients: (i) investors have private information; (ii)investors interact in a dynamic setting, weighing the high returns on domestic assets against the incentives to pull out before the devaluation. The model shows that the presence of disaggregated information delays the onset of BOP crises, giving rise to discrete devaluations. It also shows that high interest rates can be eective in delaying and possibly avoiding the abandonment of the peg. The optimal policy is to raise interest rates sharply as fundamentals become very weak. However, this policy is time inconsistent, suggesting a role for commitment devices such as currency boards or IMF pressure.

New evidence of the real interest rate parity for OECD countries using panel unit root tests with breaks

This paper tests for real interest parity (RIRP) among the nineteen major OECD countries over the period 1978:Q2-1998:Q4. The econometric methods applied consist of combining the use of several unit root or stationarity tests designed for panels valid under cross-section dependence and presence of multiple structural breaks. Our results strongly support the fulfilment of the weak version of the RIRP for the studied period once dependence and structural breaks are accounted for.

New evidence of the real interest rate parity for OECD countries using panel unit root tests with breaks

This paper tests for real interest parity (RIRP) among the nineteen major OECD countries over the period 1978:Q2-1998:Q4. The econometric methods applied consist of combining the use of several unit root or stationarity tests designed for panels valid under cross-section dependence and presence of multiple structural breaks. Our results strongly support the fulfilment of the weak version of the RIRP for the studied period once dependence and structural breaks are accounted for.

The role of central bank operating procedures in an economy with productive government spending

The choice of either the rate of monetary growth or the nominal interest rate as the instrument controlled by monetary authorities has both positive and normative implications for economic performance. We reexamine some of the issues related to the choice of the monetary policy instrument in a dynamic general equilibrium model exhibiting endogenous growth in which a fraction of productive government spending is financed by means of issuing currency. When we evaluate the performance of the two monetary instruments attending to the fluctuations of endogenous variables, we find that the inflation rate is less volatile under nominal interest rate targeting. Concerning the fluctuations of consumption and of the growth rate, both monetary policy instruments lead to statistically equivalent volatilities. Finally, we show that none of these two targeting procedures displays unambiguously higher welfare levels.

Is bank debt special for the transmission of monetary policy? Evidence from the stock market

We combine existing balance sheet and stock market data with two new datasets to studywhether, how much, and why bank lending to firms matters for the transmission of monetarypolicy. The first new dataset enables us to quantify the bank dependence of firms precisely,as the ratio of bank debt to total assets. We show that a two standard deviation increase inthe bank dependence of a firm makes its stock price about 25% more responsive to monetarypolicy shocks. We explore the channels through which this effect occurs, and find that thestock prices of bank-dependent firms that borrow from financially weaker banks display astronger sensitivity to monetary policy shocks. This finding is consistent with the banklending channel, a theory according to which the strength of bank balance sheets mattersfor monetary policy transmission. We construct a new database of hedging activities andshow that the stock prices of bank-dependent firms that hedge against interest rate riskdisplay a lower sensitivity to monetary policy shocks. This finding is consistent with aninterest rate pass-through channel that operates via the direct transmission of policy ratesto lending rates associated with the widespread use of floating-rates in bank loans and creditline agreements.

Credit markets and the propagation of monetary policy shocks

This paper analyzes the propagation of monetary policy shocks through the creation of credit in an economy. Models of the monetary transmission mechanism typically feature responses which last for a few quarters contrary to what the empirical evidence suggests. To propagate the impact of monetary shocks over time, these models introduce adjustment costs by which agents find it optimal to change their decisions slowly. This paper presents another explanation that does not rely on any sort of adjustment costs or stickiness. In our economy, agents own assets and make occupational choices. Banks intermediate between agents demanding and supplying assets. Our interpretation is based on the way banks create credit and how the monetary authority affects the process of financial intermediation through its monetary policy. As the central bank lowers the interest rate by buying government bonds in exchange for reserves, high productive entrepreneurs are able to borrow more resources from low productivity agents. We show that this movement of capital among agents sets in motion a response of the economy that resembles an expansionary phase of the cycle.

On the choice of an exchange rate regime: target zones revisited

From the classical gold standard up to the current ERM2 arrangement of the European Union, target zones have been a widely used exchange regime in contemporary history. This paper presents a benchmark model that rationalizes the choice of target zones over the rest of regimes: the fixed rate, the free float and the managed float. It is shown that the monetary authority may gain efficiency by reducing volatility of both the exchange rate and the interest rate at the same time. Furthermore, the model is consistent with some known stylized facts in the empirical literature that previous models were not able to produce, namely, the positive relation between the exchange rate and the interest rate differential, the degree of non-linearity of the function linking the exchage rate to fundamentals and the shape of the exchange rate stochastic distribution.