A model for ex ante real interest rates

Abstract

This paper proposes a new model for estimating economic agents' anticipation of the real rate of interest. It decomposes the nominal short-term interest rate into an ex ante real interest rate and an expected inflation rate, according to Fisher's equation. Assume the ex ante real interest rate follows an autoregressive structure and inflation follows an IMA(1, 1) process. Using the information in the nominal short-term interest rate and the inflation series, the ex ante real interest rate is estimated by maximum likelihood using the Kalman filter to calculate the likelihood function. The results show that the time series of estimates of the ex ante real interest rate extracted from the model rejects the random-walk hypothesis at the 1% significance level.