Inflation, hedging, and the fisher hypothesis

Abstract

This paper presents an interest rate equation that is based on the “inverted Fisher hypothesis” but that allows for a time-variant interest premium corresponding to the implicit return on monetary services. This premium is decomposed into time-variant capital risk and hedging premiums. Empirical evidence from Canada, the U.K. and the U.S. indicates that the short-run behavior of interest rates can be explained much better with a dynamic form of this interest rate equation than with the standard Fisher equation.