Abstract
This paper considers the real interest rate parity (RIRP) in OECD countries applying a sequential panel selection (SPS) method on alternative panel unit-root tests. Our approach exploits the enhanced power of panels to uncover evidence of stationarity, but also identifies the exact countries for which the RIRP holds in a panel. Moreover, we construct real interest rate measures using alternative approaches, including a Markov regime-switching procedure, which is consistent with the forward-looking nature of inflation expectations formation. Considering US as the benchmark economy, we produce strong evidence of stationarity in real interest rate differentials, which resuscitates RIRP, especially given the inconclusive results in the related literature. Our results are robust to different panel unit-root tests, measures of inflation expectations, and interest rate maturities. The RIRP appears quite resilient in the face of the global financial crisis and the low real interest rate environment after the great recession. The SPS allows to calculate half-lives, which avoid the pitfalls of over/underestimating the speed of adjustment and are lower as compared to the typical estimates in the literature.
| Original language | English |
|---|---|
| Pages (from-to) | 1-17 |
| Number of pages | 17 |
| Journal | European Journal Of Finance |
| Early online date | 29 Nov 2017 |
| DOIs | |
| Publication status | E-pub ahead of print - 29 Nov 2017 |
Keywords
- cross-sectional dependence
- half-lives
- inflation expectations
- Markov regime switching
- panel unit-root tests
- real interest rate parity
