What is driving the Capital Inflows to Costa Rica? Risk Premium and Interest Rate Differentials

Jorge Leon and Melissa Vega

MPRA Paper from University Library of Munich, Germany

Abstract: The goal of this paper is to analyse the interest rate differential as the possible main factor behind the capital inflows experienced by Costa Rica during the second semester of 2012. For this purpose, a panel data model for interest rate differential is estimated taking into consideration an array of relevant macroeconomic variables. The results suggest that interest rate differentials for Costa Rica in 2012 are above what the estimated model predicts for the lending rate and deposit rate by 8.4 pp., and between 2.7 p.p. and 1.7 p.p., respectively. This excess in the interest rate differential could explain the observed capital inflows. Therefore, a reduction of lending and deposit interest rate differentials is crucial, but an extra effort has to be made to reduce the lending rate differential. As a consequence of the prevailing situation, the difference between lending and deposit rate in Costa Rica is greater than in countries with similar levels of risk.

Keywords: Interest Rate; Risk Premium; Uncovered Interest Rate Parity (search for similar items in EconPapers)
JEL-codes: E50 F36 G15 (search for similar items in EconPapers)
Date: 2013-11
New Economics Papers: this item is included in nep-mac
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