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The Term Structure of Interest Rate Differentials in a Target Zone: Theory and Swedish Data
Stockholm University, Faculty of Social Sciences, Institute for International Economic Studies.
1990 (English)Report (Other academic)
Abstract [en]

The term structure of interest rate differentials is derived in a model of a small open economy with a target zone exchange rate regime. The target zone is modeled as a regulated Brownian motion. The interest rate differentials are computed as the solution to a parabolic partial differential equation with derivative boundary conditions, both via a Fourier-series analytical solution and via a direct numerical solution. Several specific properties of the term structure of interest rate differentials are derived. For instance, for given time to maturity the interest rate differential is decreasing in the exchange rate, and for given exchange rate the interest rate differential's absolute value and its instantaneous variability are both decreasing in the time to maturity. Devaluation/realignment risks are incorporated and imply upward shifts of the interest rate differentials. Some implications of the theory are found to be broadly consistent with data on Swedish exchange rates and interest differentials for the period 1986-1989.

Place, publisher, year, edition, pages
Stockholm: IIES , 1990. , 57 p.
Series
Seminar Paper / Institute for International Economic Studies, Stockholm University, ISSN 0347-8769 ; 466
Keyword [en]
term structure, interest rates, target zones, exchange rates, realignment, regulated Brownian motion, devaluation risks
National Category
Economics
Identifiers
URN: urn:nbn:se:su:diva-41769OAI: oai:DiVA.org:su-41769DiVA: diva2:337712
Available from: 2010-08-09 Created: 2010-08-09 Last updated: 2010-08-09Bibliographically approved

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Svensson, Lars E.O.
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CiteExportLink to record
Permanent link

Direct link
Cite
Citation style
  • apa
  • ieee
  • modern-language-association-8th-edition
  • vancouver
  • Other style
More styles
Language
  • de-DE
  • en-GB
  • en-US
  • fi-FI
  • nn-NO
  • nn-NB
  • sv-SE
  • Other locale
More languages
Output format
  • html
  • text
  • asciidoc
  • rtf