Hierarchical Bayesian semiparametric models for international inflation and interest rates.

Abstract

Given the importance of the inflation, nominal and interest rates on economy, volumes of papers have been focused on them for past several decades. However, the economic literature shows no consensus on the findings and controversies still remain. This dissertation empirically investigates the relationship among inflation, nominal and real interest rates. The empirical model relaxes the assumption that real rates are constant and allows them to change over time. In addition, the model provides a framework for analyzing the relationship among multiple countries simultaneously. The major conclusions are: First, it improves estimation of the relationship between inflation and nominal interest rate by accounting for non-constant real rates. Nominal rates and inflation move together, and the degree of adjustment is about the same as predicted theoretically. Our results also provide additional supporting evidence to the existing literature for the United States. Second, this model detects the serial variations in the real rates and captures its movement. That is, the nonparametric function well captures the characteristic of the real rates movement for each country. Third, the model also detects serial substantial cross-sectional correlations for multiple countries. One objective of the dissertation is to propose a global real rate index. A global real rate is not well defined, and the dissertation offers several interpretations. One general approach among three methods is by using Markowitz portfolio theory. Here, country-specific real rates are weighted according to their long-term mean return, volatility, and inter-correlations. In summary, this research uses a multivariate, hierarchical Bayes, semiparametric regression model to investigate the relationship between inflation, nominal and real interest rates for multiple countries simultaneously. The model allows for time varying real interest rates for each country. The results show that there is some variation in the real rates over time and across countries, and in the last decade, real rates are declining for most countries. Three methods are provided to construct a global real rates index from three different perspectives. From an investor's point of view, the global real rate index can be treated as a benchmark when making multiple countries comparisons and investment allocations.