Why are Real Interest Rates so High?
Boston University - Department of Finance & Economics
University of California, San Diego (UCSD) - Graduate School of International Relations and Pacific Studies (IRPS)
Robert L. McDonald
Northwestern University - Kellogg School of Management
NBER Working Paper No. w1141
This paper applies the Capital Asset Pricing Model to help explain the anomalous behavior of real interest rates during the last several years. Specifically,we are able to show that the increased volatility of bond prices since the change in Federal Reserve operating procedure in October 1979 has substantially increased the required real risk premium on long term bonds. We also consider and reject the possibility that increased risk alone accounts for the recent increase in the short-term real rate. Finally, we use the model to simulate the financial effects of a Federal debt maturity management operation.
Number of Pages in PDF File: 42
Date posted: July 5, 2004