Interest Rate Theory Research Articles

Generating Future and Present Values of Annuity Using Interest Rate Theory

Generating Future and Present Values of Annuity Using Interest Rate Theory

Revisiting elastic string models of forward interest rates

Twenty five years ago, several authors proposed to describe the forward interest rate curve (FRC) as an elastic string along which idiosyncratic shocks propagate, accounting for the peculiar structure of the return correlation across different maturities. In this paper, we revisit the specific ‘stiff’ elastic string field theory of Baaquie and Bouchaud [Stiff field theory of interest rates and psychological future time. Wilmott Mag., 2004, 2–6] in a way that makes its micro-foundation more transparent. Our model can be interpreted as capturing the effect of market forces that set the rates of nearby tenors in a self-referential fashion. The model is parsimonious and accurately reproduces the whole correlation structure of the FRC over the time period 1994–2023, with an error around 1% and with only one adjustable parameter, the value of which being very stable across the last three decades. The dependence of correlation on time resolution (also called the Epps effect) is also faithfully reproduced within the model and leads to a cross-tenor information propagation time on the order of 30 minutes. Finally, we confirm that the perceived time in interest rate markets is a strongly sub-linear function of real time, as surmised by Baaquie and Bouchaud [Stiff field theory of interest rates and psychological future time. Wilmott Mag., 2004, 2–6]. In fact, our results are fully compatible with hyperbolic discounting, in line with the recent behavioral Finance literature Farmer and Geanakoplos [Hyperbolic Discounting is Rational: Valuing the Far Future with Uncertain Discount Rates, Cowles Foundation Discussion Papers, 2009 (Cowles Foundation for Research in Economics, Yale University)].

Inter-Sectoral Linkages in Nigeria: Evidence from Agriculture and Manufacturing Sectors

The main purpose of the research was to establish determinants of commercial bank growth. The specific objectives of the study was to; determine the effect of default rate on loans on growth of commercial banks, determine the effect of level of interest income on growth of commercial banks and to establish the effect of forex transaction volume on growth of commercial banks listed in Nairobi Securities Exchange. The study was guided by the interest rate theory, international fisher effect theory and time preference theory. Using multiple regression analysis, we found support for the proposition that loan default rate, interest rate and forex transaction had a significant effect on growth of commercial banks. Keywords: Growth of commercial bank, default rate on loans, interest income and forex transaction volume DOI : 10.7176/DCS/9-1-06

The effect of Asset quality on the Value of Commercial Banks in Kenya

Well-functioning banks diminish not only the transaction costs, but also the moral hazard and asymmetric information issues observed in the financial market. Despite the role played in financial inclusion, commercial banks in Kenya have seen increased liquidity risk, declining profitability and credit risk that has weakened the sector's stability. This research sought to determine the effect of asset quality on commercial banks value in Kenya. The study was anchored on four main theories including Capital Structure Irrelevance Theory, Interest Rate Theory, Signaling theory and liquidity preference theory. This study adopted an explanatory research design and followed a positivism research philosophy. The study involved all the 43 commercial banks in Kenya which were selected using census sampling. The study covered a 7-year period between 2014 and 2021. Secondary data was used for the study and was obtained from the audited annual financial reports of the commercial banks in Kenya and CBK. The collected data was analyzed by uses of descriptive and inferential analysis with the help of Statistical Package for Social Sciences (SPSS) version 26 and STATA. Tables and figures were used to present the analyzed data. The study established that Asset Quality has a positive impact on the commercial banks value in Kenya. The study concludes that banks should improve their asset quality by adopting effective risk management strategies and banks to improve their management efficiency by investing in employee training and development programs, adopting technology to automate processes, and streamlining operations. Commercial banks can improve their liquidity by implementing effective liquidity risk management strategies. The study recommends the banks to improve their asset quality by adopting effective risk management strategies.

The effect of capital adequacy on the Value of Commercial Banks in Kenya

Well-functioning banks diminish not only the transaction costs, but also the moral hazard and asymmetric information issues observed in the financial market. Despite the role played in financial inclusion, commercial banks in Kenya have seen increased liquidity risk, declining profitability and credit risk that has weakened the sector's stability. This research sought to establish the effect of capital adequacy on value of commercial banks in Kenya. The study was anchored on four main theories including Capital Structure Irrelevance Theory, Interest Rate Theory, Signaling theory and liquidity preference theory. This study adopted an explanatory research design and followed a positivism research philosophy. The study involved all the 43 commercial banks in Kenya which were selected using census sampling. The study covered a 7-year period between 2014 and 2021. Secondary data was used for the study and was obtained from the audited annual financial reports of the commercial banks in Kenya and CBK. The collected data was analyzed by uses of descriptive and inferential analysis with the help of Statistical Package for Social Sciences (SPSS) version 26 and STATA. Tables and figures were used to present the analyzed data. The study established that Capital adequacy has a positive impact on the commercial banks value in Kenya. The study concludes that financial soundness indicators such as capital adequacy are more important in determining the ability of a bank to produce value for its share-holders. The study recommends banks to improve their capital adequacy by retaining profits or raising new capital through various means such as issuing new shares, selling assets, or borrowing from financial institutions. Additionally, banks to improve their asset quality by adopting effective risk management strategies and banks should improve their management efficiency by investing in employee training and development programs, adopting technology to automate processes, and streamlining operations. Commercial banks can improve their liquidity by implementing effective liquidity risk management strategies.

Interest Rates Capping and Credit Uptake of Commercial Banks in Kenya

In 2016, Kenya enacted the Banking (amendment) Act 2016 which allowed lending interest rates charged by Commercial Banks in Kenya to be fixed at the Central Bank Rate plus a spread of 4% and deposit rates at 70% of the Central Bank Rate. Many banks protested this move since it meant reduced profitability. As a result, commercial banks introduced stringent credit qualification criteria locking out many borrowers who would have otherwise qualified for credit. Therefore, this study sought to establish how interest rate capping affects credit uptake of Commercial Banks in Kenya. The objectives of the study were; to determine the effect of capping lending interest rates, capping deposit interest rates, deposit interest rate spread on credit uptake of commercial banks in Kenya and the moderating effect of inflation risk premium on the relationship between interest rate capping and credit uptake of commercial banks in Kenya. The study was guided by four theories namely: Irving Fisher's Theory of Interest Rates, the Fisher Effect, Loan Pricing Theory and Loanable Funds Theory. The study conducted diagnostic test on multicollinearity normality test and Heteroscedasticity test. The study adopted descriptive research design. The target population for the study was all the 40 licensed commercial banks in Kenya. The sampling frame for the study was all (40) licensed commercial banks in Kenya. This study collected both primary and secondary data because both data reinforced each other. Primary data was collected using semi-structured questionnaires, while secondary data was collected from audited and released financial statements of Commercial Banks in Kenya for the period 2014–2019. The data was analyzed using multiple regressions and descriptive statistics namely: mean median, mode and standard deviation. Quantitative data was presented using tables, pie charts and bar graphs while qualitative data has been presented descriptively. The study established that while capping lending interest rates and interest rate spread had a significant effect on credit uptake of commercial banks in Kenya, capping deposit interest rates was insignificant and the relationship was significantly moderated by inflation risk premium. The study concluded that interest rate spread had the largest effect on credit uptake of commercial banks in Kenya followed by capping lending interest rates and lastly capping deposit interest rates. The study recommends that when formulating policies on interest rate capping, the Central Bank of Kenya should focus more on the lending side as compared to the deposits side. Keywords: Interest rates capping, Credit uptake, Lending interest rates, Deposit interest rates, Interest rates spread, Inflation risk premium.

Schuldentragfähigkeit mit impliziten Staatsschulden: Replik und Erwiderung

Abstract Some analyses examining the long-term sustainability of government debt use the term implicit government debt. This is an approach that is occasionally criticized. However, the concept of implicit government debt is necessary to evaluate the scope for long-term fiscal policy and to analyze the consequences of demographic change. Krämer and von Weizsäcker reject the assumption of a general positive interest rate-growth differential that is often made in these sustainability analyses. Priewe focuses on the controversy surrounding implicit government debt and explains a theory of interest rates that differs from Krämer and Weizsäcker but leads to similar results.

KEYNES AND HAYEK: COMMONALITIES AND DIFFERENCES IN BUSINESS CYCLE THEORIES

Nearly a century after the renown Keynes‑Hayek debate, the two economists are still perceived as diametrically opposed. This is certainly not true in the realm of business cycle theory where for a period of time they both employed the Wicksell inspired savings‑investment approach. The publication of Keynes’s General Theory obscured these similarities and the IS‑LM model disconnected all possible ties between the two cycle theories. However, I argue that Keynes din not succeed in the General Theory to offer a consistent interest rate theory and that his 1937 articles which were meant for further clarification were received even worse than the book itself. If Keynes’s more nihilistic variant of the liquidity preference theory would be replaced which Leijohnhufvud’s Z theory (i.e., the Treatise plus output modifications), Keynes and the Austrians would still have considerable theoretical points in common in the realm of business fluctuations. The two cycle theories would complement, rather than contradict each other.

Econometric estimation of the cost of implementing the science-intensive projects based on efficient markets data

Subject. The article investigates cost drivers of research and development, analyzes key indicators of R&D costs characterizing the technical and operational perfection of science-intensive products, using the case of civilian and multipurpose helicopters. Objectives. The aim is to develop an econometric model of dependence of R&D costs on basic performance specifications of the helicopter to decide whether R&D should be undertaken. Methods. The study rests on the theory of fundamental value of assets, econometric methods of data analysis, the time value of money, and also on the theory of purchasing power parity, and unbiased expectations theory of interest rates. Results. The paper unveils the main sources of R&D cost growth for new-generation products in the science-intensive industries. Based on the econometric analysis, we highlight the main determinants of R&D costs, i.e. flight and technical characteristics of the helicopter, which determine the operational efficiency of design and technological decisions taken. We constructed a model to obtain the predictive estimate of R&D cost for Russian helicopters costs. Conclusions. The statistics on R&D costs of Russian civil helicopters does not sufficiently reflect their fair (market) value. Efficient markets are sources of more objective data on R&D costs of science-intensive products. When modeling the market value of R&D for Russian helicopters, it is advisable to rely on the Western markets data, with recalculation of development costs according to the economic conditions of the Russian aviation market. The analog method enables to quickly obtain a preliminary estimate of R&D costs.

What Can Posterity Learn from Irving Fisher?

This essay draws attention to some of the important aspects of, and learnings from, Irving Fisher’s work. Fisher was the first economist to subject big volumes of data to analysis. He was one of the founders and first president of the Econometric Society. His name is associated with the quantity theory of money. He researched the purchasing power of money, index numbers, created the so-called Fisher index, wrote about the theory of interest rates, economic cycles, dwelled upon debt deflation and the theory of the Great Depression. He was one of the first advocates of abandoning the gold standard. He also drew attention to the psychological motives of the behaviours of economic actors, so the theories of Thalerian behavioural economics can regard him as their predecessor. His insight was used in managing the financial crisis of 2008. The steps towards reforming bank regulation can specifically be regarded as such measures, while Modern Monetary Theory stretched back as far as his thoughts on the regulation of the creation of money, i.e. the Chicago plan.

Relationship between lending interest rate, inflation rate and capital formation in Kenya

The study seeks to understand the relationship between lending interest rate, inflation rate and capital formation in Kenya. Time series from World Bank for the 1988 to 2018 is employed. Development of literature is guided by expectation theory, classical theory of interest rate and the institutionalist theory of capital formation. The study finds capital formation, lending interest rate ad inflation rate time series data to be stationary at the 5% level of significance. This leads to the checking of the lag order used and estimating of VAR model. The results indicate that, current year’s; capital formation, inflation rate and lending interest rate are insignificant in determining next year’s level of capital formation. First lag of inflation rate is found positively significant in influencing lending interest rates as well as the first lag of lending interest rate is found significant on influencing itself. Capital formation first lag is found to be negatively significant in determining inflation rate. Lastly, inflation rate first lag is found to be positive

Interest Rate Theory in Islamic Economic Perspective

Inflation is a condition in which there is a sharp (absolute) increase in prices that lasts continuously for a long period of time followed by a decline in the real (intrinsic) value of a country's currency. circulating through an increase in bank interest rates. For this reason, the government carries out monetary policy by suppressing the money supply through increasing bank interest rates. However, the interest rate has various kinds, namely classical interest rate theory, neo classical, modern keyness and hicks. Therefore, this study focuses more on interest rates and the theory of interest rates by experts. So that it produces descriptive research.

On the theory of credit and interest rate

Taking into account the peculiarities of the methodology of "pure economic theory" the article explores the issue of the root prerequisites for the emergence of credit relations. To this end, the model of simple exchange economy has been chosen as the object of analysis, being further simplified by abstracting from all phenomena and processes occurring outside the sphere of circulation. The vulnerable points of the two available approaches to analysis of the general nature of credit are shown: of that, which combines current and future goods within a single utility function, and that, which is based upon the assumption that consumers possess the so-called time preference. It has been demonstrated that within the framework of the adopted restrictions, the existence of goods, which generate a flow of services to consumers ("capital consumer goods"), rather than provide them with one-time satisfaction is the sufficient condition for the emergence of credit. In the course of solving the problem set in the article, an inextricable link between the current and transtemporal exchange is revealed, as well as a single basis for consumer and production credit — their use for investment purposes. It also becomes clear that credit relationships logically precede money, not the other way around as is often assumed when analyzing it.

The causes and challenges of low interest rates: insights from basic principles and recent literature

PurposeWhat causes the downward trend of real interest rates in major developed economies since the 1980s? What are the challenges of the near-zero interest and inflation rates for monetary policy? What can the policymakers learn from the latest developments in the monetary and interest rate theory? This paper aims to answer these questions by reviewing both basic principles of interest rate determination and recent academic and policy debates.Design/methodology/approachThe paper critically reviews the explanations for the downward trend of real interest rates in recent decades and monetary policy options in a near-zero interest rate environment.FindingsThe decline of real interest rates is likely an outcome of multiple technological, social and economic factors including diminished productivity growth, changing demographics, elevated tail-risk concerns, time-varying convenience yields of safe assets, increased global demand for safe assets, rising wealth and income inequality, falling relative price of capital, accommodative monetary policies, and changes in industry structure that alter the investment and saving behaviors of the corporate sector. The near-zero interest rate limits the space of central banks' response to economic crises. It also challenges some conventional wisdoms of monetary theory and sparks radically new ideas about monetary policy.Originality/valueThis survey differs from the existing work by taking a broader view of both economics and finance literature. It critically assesses the economic forces driving the global decline of real interest rates through the lens of basic principles and empirical evidence and discusses the merits and limitations of each proposed explanation. The study emphasizes the importance of a better understanding of economic forces driving diverging trends of corporate investment and saving behaviors. It also discusses the implications of the neo-Fisherism and the fiscal theory of price level for monetary policy in a low interest rate environment.

INTERBANK CREDIT RISK MODELING WITH SELF-EXCITING JUMP PROCESSES

The credit crunch of 2007 caused major changes in the market of interbank rates making the existing interest rate theory inconsistent. This paper puts forward one way to reconcile practice and theory by modifying the arbitrage-free condition. In this framework, the forward Libor rate is no longer considered as a risk-free rate and the credit and liquidity risks within the interbank market partly drive its dynamics. In a similar manner to the multiple-curve approach, we model the evolution of default-free rates, assimilated to overnight interest swap rates, and the default times of an interbank market segment determined by its tenor. For each segment, we use the reduced form approach to model the arrival rate of defaults with a self-exciting jump-diffusion process. Then, we deduce the dynamics of the spot forward Libor rates and provide closed-form approximation pricing formulae for options on forward Libor rates and swap rates. Even in a context of negative interest rates and compared to other forms of intensity processes such as a CIR, the self-excitation property allows a better understanding of the spread OIS-IRS and provides information about the interbank credit risk. Furthermore, our framework enables to parse the impact of the interbank credit risk on forward Libor as well as on interest rates derivatives like caps, floors, and swaptions.

Monetary economics after the global financial crisis: what has happened to the endogenous money theory?

The 2010s have witnessed a new shift in central banking and, partially at least, in monetary economics and macroeconomic modelling. It is a fact that the endogenous money theory has been gradually clawing back popularity at the expense of the classical theory of interest rates, the financial intermediation view of banks, the money-multiplier story and the quantity theory of money. However, the loanable funds theory and the view of banks as pure financial intermediaries (sometimes coupled with the money-multiplier story) are still sometimes invoked. In addition, the dynamic process of creation, circulation and destruction of money is usually neglected. The point is that money endogeneity is still regarded by many mainstream economists as a mere empirical fact, not a key feature of capitalist market-based economies to be properly explained by a logically consistent theory. By contrast, dissenting economists have further advanced the endogenous money view through: (a) a generalised theory of the endogenous process of money creation; (b) the increasing popularity of modern monetary theory in the public debate; and (c) the development of aggregative stock–flow consistent models and agent-based stock–flow consistent models as an alternative to dynamic stochastic general equilibrium models.

Theory of Cryptocurrency Interest Rates

A term structure model in which the short rate is zero is developed as a candidate for a theory of cryptocurrency interest rates. The price processes of crypto discount bonds are worked out, along with expressions for the instantaneous forward rates and the prices of interest-rate derivatives. The model admits functional degrees of freedom that can be calibrated to the initial yield curve and other market data. Our analysis suggests that strict local martingales can be used for modeling the pricing kernels associated with virtual currencies based on distributed ledger technologies.

Continuous-time multi-cohort mortality modelling with affine processes

Continuous-time mortality models, based on affine processes, provide many advantages over discrete-time models, especially for financial applications, where such processes are commonly used for interest rate and credit risks. This paper presents a multi-cohort mortality model for age-cohort mortality rates with common factors across cohorts as well as cohort-specific factors. The mortality model is based on well-developed and used techniques from interest rate theory and has many applications including the valuation of longevity-linked products. The model has many appealing features. It is a multi-cohort model that describes the whole mortality surface, it captures cohort effects, it allows for observed imperfect correlation between different cohorts, it is shown to fit historical data at pension-related ages very well, it has closed-form expressions for survival curves and we show that it outperforms a number of other commonly used discrete-time mortality models in forecasting future survival curves.

The associations between stock prices, inflation rates, interest rates are still persistent

PurposeThis paper aims to examine the effect of both inflation rate and interest rate on stock prices using quarterly data on non-financial firms listed in DJIA30 and NASDAQ100 for the period 1999-2016. The stock duration model is used to measure the sensitivity in variations in inflation rates and interest rates on stock prices.Design/methodology/approachThe authors use standard statistical tools that include Johansen cointegration test, linearity, normality tests, cointegration regression, Granger causality and vector error correction model.FindingsThe results of panel Johansen cointegration analysis show that cointegration exists between the stock prices, the changes in stock prices due to inflation rates and the changes in stock prices due to real interest rates. The results of cointegration regression show that inflation rates are negatively associated with stock prices, the real interest rates and stock prices are positively associated, changes in real interest rates and inflation rates Granger cause significant changes in stock prices, significant speed of adjustment to long run equilibrium between observed stock prices and real interest rates and significant speed of adjustment to long run equilibrium between changes in stock prices due to real interest rates and changes in inflation rates.Originality/valueThis paper contributes to the empirical literature in three ways. The paper examines the effects of inflation and interest rates on stock prices differently from other related studies by separating inflation from real interest rates. The paper examines the causality between stock prices, interest and inflation rates. This paper offers significant updated validity to extended literature that a negative association exists between stock prices and inflation rates. This validity can be considered as an existence a theory of stock prices, inflation rates and interest rates.

Negative Interest Rate Risk. Atavism or Normalization of Central Banks’ Monetary Policy

In the face of the global financial crisis, central banks have used unconventional monetary policy instruments. Firstly, they implemented the interest rate policy, lowering base interest rates to a very low (almost zero) level. However, in the following years they did not undertake normalizing activities. The macroeconomic environment required further initiatives. For the first time in history, central banks have adopted Negative Interest Rate Policy (NIRP). The main aim of the study is to explore the risk accompanying the negative interest rate policy, aiming at identifying channels and consequences of its impact on the economy. The study verifies the research hypothesis stating that the risk of negative interest rates, so far unrecognized in Theory of Interest Rate, is a consequence of low effectiveness of monetary policy normalization and may adopt systemic nature, by influencing – through different channels – the financial stability and growth dynamics of the modern world economy.