 The convergence of international interest rates prior to Monetary UnionNo 127, HWWA Discussion Papers from Hamburg Institute of International Economics (HWWA) Abstract: The process of international interest rate convergence for arbitrary terms (represented by the term structure of interest rate differentials) is derived in a model of a small open economy which faces a purely time-contingent exchange rate regime switch from flexible to fixed rates. Special attention is paid to a situation in which financial markets deem a delay in the regime switch beyond the publicly announced fixing date possible. The closed-form solution of the term structure allows us to analyze the volatility of interest rate differentials thus providing a useful tool for interest-rate-sensitive security valuation and other risk management applications. Furthermore, the model demonstrates that the economy under consideration has to pay for the exchange rate stabilization triggered by the mere announcement of future regime switching by a higher uncertainty in the evolution of domestic interest rates. Keywords: Exchange rate regime switches; interest rates; term structure; stochastic processes; uncertainty (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:zbw:hwwadp:26165 Access Statistics for this paper More papers in HWWA Discussion Papers from Hamburg Institute of International Economics (HWWA) Contact information at EDIRC. |
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