A behavioral analysis of the volatility of interbank interest rates in developed and emerging countries.
| Autor | Rossetti, Nara |
| Cargo | Interbank interest rates |
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Introduction
The main goal of most macroeconomic policies is the continuous growth of the gross domestic product in conjunction with low inflation, so the maintenance of price stability has a significant role in the economic growth rate (Nguyen, 2015). Among macroeconomic policies, monetary policy is responsible for liquidity control within the economic system, and the main instrument of this policy is the control of interest rates.
Thus, changes in monetary policy can lead to changes in interest rates. According to Karagiannis et al. (2010), monetary policy is one of the two main tools in standard economic theory that governments can use to influence production, investment, prices and employment in the economy. Monetary policy can affect the main macroeconomic variables through three channels: interest rate, bank loans and credit expansion.
When the Central Bank has adopted a tight monetary policy, i.e. raising the interest rate causes an increase in funding costs of banks and thus a reduction in loan growth (Macit, 2012). The adjustment of retail bank interest rates (deposit and loan rates) in response to changes in wholesale rates (central bank and interbank money market rates) is a key element in the transmission mechanism of the interest rate. In an effective monetary policy, any change in the interest rate charged by the central bank must be transmitted to interest rates in the retail (consumer) market and will influence business loan rates, thereby affecting domestic aggregate demand and production (Karagiannis et al., 2010).
The purchase and sale of government securities is one means of controlling the money supply; for example, when there is excess money in circulation, selling government securities can help remove currency from the market, whereas purchasing government securities can help inject capital into the economy. According to Mankiw (2005), monetary policy "can be described either in terms of the money supply or in terms of the interest rate". Mankiw (2005) uses the example of the US Federal Open Market Committee (FOMC), to illustrate this point: when the FOMC sets a target for the interest rate, public debt securities traders will perform all possible open market operations to ensure that the equilibrium interest rate equals the target set by the FOMC, which adjusts the money supply accordingly.
Interbank interest rates are the basis of interbank market operations. When purchasing a bank's deposit certificate, an investor becomes a creditor of this institution, turning this security into a fixed income asset.
The fixed income concept, according to Haugen (1997), is that receipts will never exceed the initially agreed upon value, although this value can be lower in the case of default because these assets have certain scheduled payments, according to Pinheiro (2009), and investors thus know cash flows in advance. These fixed income securities are called bonds.
Fabozzi (2000) posits that bonds are a debt instrument pursuant to which issuers (debtors) are obligated to pay investors (lenders) the amount borrowed plus interest. When a bond pays periodic interest, these payments are referred to as coupons.
Fixed income assets can be classified into two types:
(1) fixed-rate, in which the coupon is established at the time the bond is acquired because the interest rate is fixed over the bond payment period; and
(2) floating-rate, in which the coupon payment varies according to the variation of a predetermined indexing rate, which can be the interbank interest rate or an inflation index, for example.
In the fixed income market, investors seek assets that provide immediate liquidity and the maximum possible protection for their portfolios. In the Brazilian fixed income market, for example, high interest rates (which are typical in high inflation years) can make long-term fixed-rate securities unattractive, due to their implied higher risk. Thus, because it has a floating rate, the one-day interbank deposit certificate (CDI) was eventually chosen as the benchmark in this market. According to the BM&FBOVESPA (2011), "the CDI acquired the role of a quasi-currency for most economic agents".
According to Gertler and Karadi (2010), the Federal Reserve manipulated the federal funds rate to implement monetary policy by affecting market interest rates during most of the post-war period, thus avoiding making loans directly into private markets. For Gertler and Karadi (2010), the situation changed dramatically after the beginning of the subprime crisis, when countries were forced to adopt and implement two types of emergency economic policies to minimize the effects of the crisis: monetary policies and policies involving the intervention of financial institutions (Acioly et al., 2010).
In choosing to aim to minimize the impact of the financial crisis with the second option, the federal reserve system (FED) injected credit directly into the private markets, when it allowed financial institutions to obtain discounts in the exchange of government debt securities for high-risk private securities. Following the bankruptcy of Lehman Brothers, the FED began a series of more dramatic interventions in the financial system, such as by lending money in high-credit risk markets, helping revitalize the commercial paper market and buying mortgage-backed debts (Gertler and Karadi, 2010).
According to Krugman and Obstfeld (1999), increasing a country's money supply leads its currency to depreciate in the foreign exchange market because an increased money supply increases the economy's liquidity and depreciates its currency as a result of a higher price level. Thus, the country's currency depreciates against the currency of other countries in the foreign exchange market. To avoid this effect, the central bank may raise interest rates to reduce liquidity and generate currency appreciation in the foreign exchange markets.
This paradigm demonstrates that controlling the interest rate becomes the nation'smain monetary policy instrument, which leads central banks to use this mechanism to control liquidity levels in the economy in terms of both domestic and foreign currencies. One way to analyse the performance of these variables is by analysing market volatility, which represents a risk measure because it is the conditional variance of a security return. Knowing the past (historical) volatility of returns and the methods for forecasting asset volatility is essential to allocating funds in a portfolio and can be one way to identify the characteristics of different markets.
Thus, this study aims to analyse the volatility of fixed income market returns in the BRICS countries (Brazil, Russia, India, China and South Africa), three Latin American countries (Argentina, Chile and Mexico) and three developed countries (the USA, Japan and Germany). This analysis seeks to establish which of the autoregressive conditional heteroscedasticity (ARCH), generalized autoregressive conditional heteroscedasticity (GARCH), exponential generalized autoregressive conditional heteroscedasticity (EGARCH), threshold generalized autoregressive conditional heteroscedasticity (TGARCH) and periodic generalized autoregressive conditional heteroscedasticity (PGARCH) models and which combination thereof with autoregressive integrated moving average (ARIMA) models is the most efficient for modelling the volatility structure of interbank interest rates in these countries.
The choice of countries in the survey is made with the following reasoning. In addition to being geographically close, the Latin American countries have similar economic and financial characteristics. The countries comprising BRICS are part of a "bloc" created by economist Jim O'Neill in 2001 to describe the major emerging countries of the world (South Africa was the last to join the bloc in 2011), and developed countries were chosen according to the World Bank (2011).
This paper is divided into five sections. This section is an introduction that contextualizes and justifies the study's topic and presents its objective. Section 2 presents a literature review on the volatility of financial assets. Section 3 describes the research methodology, and Section 4 presents the results found in the models developed herein. Finally, Section 5 discusses the final considerations of the study.
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Literature review
For Alexander (2005), asset prices can be observed now and in the past, but it is not possible to determine how these same prices will behave in the future because asset prices are random variables (stochastic) and non-deterministic. According to Taylor (2005), the speed at which asset prices change is called volatility, and for Wilmott (2001), volatility is how fluctuations in the price of an asset are measured and are therefore a risk measure. The risk is associated with the uncertainty regarding the return on assets, and return is the price fluctuation that these assets experience.
Enders (2004) adds that knowledge of the dynamics of a series provides a more accurate forecast, provided that each of the expected components can be extrapolated into the future.
According to Alexander (2005), relative changes in prices are typically measured by the difference in the logarithm of prices that have a normal distribution.
Thus, the return on an asset price can be defined as the following (Fama, 1965):
[r.sub.t] = [log.sub.e][p.sub.t + 1] - [log.sub.e][p.sub.t]
where [r.sub.t] is the return on securities, [p.sub.t] is the security price in period t and [p.sub.t+1] is the security price in a subsequent period.
In economic and financial series, the asset price behaviour is not typically constant over a long period. Prices respond to internal and external changes in macroeconomic variables and other events that generate insecurity for portfolio managers and investors.
According to Stock and Watson (2004), in economic time series, some periods are more stable than others because series volatility...
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