The Term Structure of Interest Rate Differentials in a Target Zone: Theory and Swedish Data

Lars Svensson

No 3374, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

Date: 1990-06
Note: ITI IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (40)

Published as Journal of Monetary Economics, Vol. 28, pp. 87-116, (1991).

Downloads: (external link)
http://www.nber.org/papers/w3374.pdf (application/pdf)

Related works:
Journal Article: The term structure of interest rate differentials in a target zone: Theory and Swedish data (1991)
Working Paper: The Term Structure of Interest Rate Differentials in a Target Zone: Theory and Swedish Data (1991)
Working Paper: The Term Structure of Interest Rate Differentials in a Target Zone: Theory and Swedish Data (1990)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:3374

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w3374

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().