An empirical analysis of real interest rate parity for industrialized countries

Abstract

This study examines whether the real interest rate parity hypothesis holds, using two different methods for computing the real interest rate. We present empirical evidence on the RIP hypothesis for thirteen industrialized countries against the US in the 1967-2008 period. This is done by employing not only classical regression analysis and standard cointegration tests, but also cointegration tests that determine the regime shift endogenously. Our results provide strong evidence in favour of bilateral real interest rate convergence between the US and several countries in our sample, in particular for long-term real interest rates. The evidence suggests that deviations from RIP have a half-life of approximately 6-9 quarters. We also provide an application of approximation of the ESTAR model, which allows for possible nonlinearities in international real interest rate dynamics.