A Study on Dynamic Behavior of Real Interest Rate Differentials

This study develops and employs a multi-country dynamic framework of real interest rate parity (RIP) to examine dynamic behavior of capital mobility among countries. I investigate and compare the evidences for the validity of the RIP in the short run and in the long run by using the approach of Vector Autoregression (VAR). Using monthly nominal Euro‐currency deposit rates for the U.S. and five OECD countries from 1991 to 2000, this work shows that the evidence against the short‐run RIP is overwhelming in all 6 countries. More interestingly, however, this work also finds significant evidence for the long‐run RIP. This empirical evidence is supportive of the hypothesis that real interest rates across countries are equalized in the long run despite the short‐run violations. This finding is consistent with the prediction of theories of international capital market models with risk premium and sticky prices. The work is expected to contribute to better understanding and providing further evidence of capital mobility and financial market integration in OECD countries.