The interest rate pass‐through describes how changes in a reference rate (the monetary policy, money market or T‐bill rate) transmit to bank lending rates. We review the empirical literature on the ...interest rate pass‐through and systematize it by means of meta‐analysis and meta‐regressions. Using the pass‐through to corporate lending rates as the baseline, we find systematically lower estimated pass‐through coefficients in studies that focus on the pass‐through to consumer lending rates and rates on long‐term loans. Also studies estimating the pass‐through by averaging all lending rates into one category report a lower pass‐through. Importantly, the interest rate pass‐through is significantly influenced by the country's macro‐financial environment. In economies with deepening stock markets, the estimated pass‐through strengthens significantly. Interestingly, after the global financial crisis, the pass‐through weakened across the board, including because of growing trade openness and supply chain financing, rising volatility and stock market turnovers, as well as declining central bank independence. Inflation targeting frameworks, if in place, helped diminish this pass‐through weakening.
In this study, we contribute to the literature in three ways. First, we test whether the response of stock returns to interest rate differential contrasts between high and low interest rate ...environments. Second, we further test whether positive and negative interest rate differentials impact differently on stock returns. For completeness, we examine the role of negative interest rate policy in the nexus by testing whether the response of stock returns to interest rate differential varies between negative and positive low interest rate environments. The third objective becomes necessary as negative interest rate may not necessarily translate into negative interest rate differential and vice versa. Using panel data methods that allow for nonstationarity, mixed order of integration and cross‐sectional heterogeneity in the estimation process, we find contrasting evidence between the two interest rate environments. While the relationship is negative for the low interest rate economies, a positive sign is observed for the high interest rate group. The ‘asymmetry’ effect in the relationship is only evident in the short run and in addition interest rate differential tends to improve stock returns in negative interest rate environment albeit in the short run. We also find contrasting evidence between the positive and negative low interest rates where the nexus remains negative for the positive (low) interest rate group and positive nexus for negative (low) interest rate category.
In this paper, we investigate an optimal reinsurance and investment problem for an insurer whose surplus process is approximated by a drifted Brownian motion. Proportional reinsurance is to hedge the ...risk of insurance. Interest rate risk and inflation risk are considered. We suppose that the instantaneous nominal interest rate follows an Ornstein–Uhlenbeck process, and the inflation index is given by a generalized Fisher equation. To make the market complete, zero-coupon bonds and Treasury Inflation Protected Securities (TIPS) are included in the market. The financial market consists of cash, zero-coupon bond, TIPS and stock. We employ the stochastic dynamic programming to derive the closed-forms of the optimal reinsurance and investment strategies as well as the optimal utility function under the constant relative risk aversion (CRRA) utility maximization. Sensitivity analysis is given to show the economic behavior of the optimal strategies and optimal utility.
•Establish risk model with stochastic interest rate, inflation index, bonds and TIPS.•Study the optimal reinsurance and investment problem under maximizing CRRA utility.•Derive closed-forms of the optimal utility, reinsurance and investment strategies.•Give a sensitivity analysis to clarify the behavior of the risk model.
This paper studies how several macrofinancial factors are associated over time with the evolution of covered interest parity (CIP) deviations in the decade after the Global Financial Crisis. Changes ...in a number of risk- and policy-related factors have a significant association with the evolution of CIP deviations. Key measures of FX market liquidity and intermediaries' risk-taking capacity are strongly correlated with the cross-currency basis (the deviation from CIP), and the close relationship between broad U.S. dollar strength and the basis is driven mainly by a common factor depending on other safe-haven currencies' comovements. Post-crisis monetary policies also play a role, as demonstrated by the relationship between CIP deviations, central bank balance sheets, and term premia. Risk-related factors have more explanatory power than monetary policy-related factors over the entire 2010–2018 period, but they are approximately equally influential over the period's second half. Further highlighting the role of bank regulation, we offer evidence that the year-end dynamics of the three-month dollar basis depend on financial regulations targeting global systemically important financial institutions.
This paper explores the structural differences and relative goodness-of-fits of affine term structure models (ATSMs). Within the family of ATSMs there is a trade-off between flexibility in modeling ...the conditional correlations and volatilities of the risk factors. This trade-off is formalized by our classification of N-factor affine family into N + 1 non-nested subfamilies of models. Specializing to three-factor ATSMs, our analysis suggests, based on theoretical considerations and empirical evidence, that some subfamilies of ATSMs are better suited than others to explaining historical interest rate behavior.
•We study the interest rate pass-through in the euro area during the sovereign debt crisis.•The transmission of conventional monetary policy to lending rates has not changed with the crisis.•But the ...composition of the pass-through has changed.•Banks' markups were less influenced by conventional monetary policy than before the crisis.•Unconventional monetary policy helped lowering lending rates.
We investigate the pass-through of monetary policy to bank lending rates in the euro area during the sovereign debt crisis, in comparison to the pre-crisis period. We make the following contributions. First, we use a factor-augmented vector autoregression, which allows us to assess the responses of a large number of country-specific interest rates and spreads. Second, we analyze the effects of monetary policy on the components of the interest rate pass-through, which reflect banks' funding risk (including sovereign risk) and markups charged by banks over funding costs. Third, we not only consider conventional but also unconventional monetary policy. We find that while the transmission of conventional monetary policy to bank lending rates has not changed with the crisis, the composition of the pass-through has changed. Specifically, expansionary conventional monetary policy lowered sovereign risk in peripheral countries and longer-term bank funding risk in peripheral and core countries during the crisis, but has been unable to lower banks' markups. This was not, or not as much, the case prior to the crisis. Unconventional monetary policy helped decreasing lending rates, mainly due to large shocks rather than a strong propagation.
This paper presents multifactor Keynesian models of the long-term interest rate. In recent years, there have been a proliferation of empirical studies based on the Keynesian approach to interest rate ...modelling. These studies evince the connection between the long-term interest rate and the short-term interest rate. However, standard multifactor models of the long-term interest rate in quantitative finance have not been yet incorporated Keynes's insights about interest rate dynamics. Keynes's insights are introduced in two different multifactor models of the long-term interest rate to illustrate how the long-term interest rate relates to the short-term interest rate, after controlling for the central bank's policy rate, expected inflation, the central bank's inflation target, volatility in financial markets, and Wiener processes.
Abstract
This paper presents a term structure model for no-arbitrage bond yields and realized bond market volatility. Based on well-known results, realized yield curve covariation is linked to ...generalized autoregressive conditional heteroskedasticity (GARCH)-type conditional covariation. The model is tractable and its latent state variables can be filtered using an exact algorithm. In an empirical study of U.S. Treasury bond data, the model shows that conditional yield curve covariation is priced in long-term yields. Moreover, the model proves useful for multi-step ahead forecasting of realized covariation. Finally, I use the model to quantify interest-rate risk and risk compensation.
Interest-rate volatility is known to be positively level dependent, i.e. to correlate positively with interest-rate levels. However, recent research has provided compelling evidence that as interest ...rates rise, the amount of level dependence decreases. We advance this line of research by investigating the amount of volatility level dependence in an emerging market with high interest rates, and find no evidence for the positive level dependence implied by the popular log-normal forward-LIBOR market model. This has important consequences for the hedging of interest-rate derivatives: when hedging caps, using the log-normal market model can be worse than not hedging at all and it is significantly outperformed by its normally distributed counterpart, which exhibits no level dependence.
This paper uses wavelet analysis to investigate causality between the spot exchange rate and the nominal interest rate differential for seven country pairs, which includes Sweden. Impulse response ...functions are also utilized to examine the signs of how one of these variables affects the other over time. One key empirical finding from the causality tests is that there is strengthening evidence of the nominal interest rate differential Granger causing the exchange rate as the wavelet time scale increases. When considering impulse responses on how the interest rate differential affects the exchange rate, there appears to be some evidence of more negative relationships at the shorter time scales (i.e. an increase in the Swedish interest rate compared to that of another country is associated with a lower Swedish krona price of the other country's currency) and more positive relationships at the longer time scales.
•We study time scale relations between exchange rates and interest rate differentials.•Causality test is used with wavelet filtered data to study the time varying relations.•Impulse response functions present signs of the time varying relations.•We find a strong causal relation in the long run.•We also find a negative and positive relation in the short and long-run respectively.
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