Long-Term Persistence in the Real Interest Rate: Some Evidence of a Fractional Unit Root

Kon S Lai

International Journal of Finance & Economics, 1997, vol. 2, issue 3, 225-35

Abstract: This study examines the long-term persistence in ex ante real interest rates. According to the long-run Fisher effect, ex ante real rates--the difference between nominal rates and expected inflation--should be mean-reverting and have no unit root. Empirical evidence on mean reversion has been mixed and less than supportive, however. Prior analyses are restricted to integer orders of integration only. This study provides a re-appraisal of the evidence using fractional integration analysis. In addition, expected inflation is measured by inflation forecasts and not just by realized inflation rates. Empirical results strongly support that ex ante real interest rates exhibit mean reversion, but in a special manner not captured by the usual stationary processes. This finding is also corroborated by empirical results based upon ex post real rates. Copyright @ 1997 by John Wiley & Sons, Ltd. All rights reserved.

Date: 1997
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