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Term structure and interest differentials as predictors of future inflation changes and inflation differentials

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  • Guglielmo Maria Caporale
  • Nikitas Pittis

Abstract

The paper tests the unbiasedness of interest differentials and term structure as predictors of inflation differentials and inflation changes, respectively, using three-, six- and twelve-month maturities in eight major industrial countries over the period 1981-1992. The first hypothesis requires rational expectations (RE) and equality of ex-ante real interest rates, which in turn holds only in the presence of uncovered interest parity (UIP) and ex-ante purchasing power parity (PPP). The second is correct if, in addition to RE, the Fisher hypothesis and constancy of ex-ante real rates are satisfied. The empirical results lead to the rejection of both null hypotheses, although interest differentials and term structure do appear to be relatively useful for forecasting purposes. In particular, the interest differential model performs better than simple ARMA models at the shortest end of the maturity spectrum in out-of-sample forecasting.

Suggested Citation

  • Guglielmo Maria Caporale & Nikitas Pittis, 1998. "Term structure and interest differentials as predictors of future inflation changes and inflation differentials," Applied Financial Economics, Taylor & Francis Journals, vol. 8(6), pages 615-625.
    • Handle: RePEc:taf:apfiec:v:8:y:1998:i:6:p:615-625
    DOI: 10.1080/096031098332655
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    Cited by:

    1. Pelin ÖGE GÜNEY, 2013. "The Term Structure of Interest Rates: A Cointegration Analysis in the Non-Linear STAR Framework," Journal of Economics and Behavioral Studies, AMH International, vol. 5(12), pages 851-860.
    2. Tronzano, Marco, 2015. "The Expectations Hypothesis of the Term Structure in Emerging Financial Markets: Some Evidence from Malaysia (1999-2015) - La struttura a termine dei tassi di interesse nei paesi emergenti: alcune evi," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 68(4), pages 521-550.
    3. Modena, Matteo, 2008. "Yield curve, time varying term premia, and business cycle fluctuations," MPRA Paper 8873, University Library of Munich, Germany.
    4. Telatar, Erdinc & Telatar, Funda & Ratti, Ronald A., 2003. "On the predictive power of the term structure of interest rates for future inflation changes in the presence of political instability: the Turkish economy," Journal of Policy Modeling, Elsevier, vol. 25(9), pages 931-946, December.
    5. Matteo Modena, 2008. "The Term Structure and the Expectations Hypothesis: a Threshold Model," Working Papers 2008_36, Business School - Economics, University of Glasgow.
    6. Daiki Maki, 2006. "Non-linear adjustment in the term structure of interest rates: a cointegration analysis in the non-linear STAR framework," Applied Financial Economics, Taylor & Francis Journals, vol. 16(17), pages 1301-1307.

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