Interest rate risk in an emerging economy

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The sharp decrease in inflation over the last decade - from 26% in 1990 to 4% in 2001 - led the Central Bank of Chile to set its monetary policy interest rate in nominal terms since August 2001. This paper analyzes the effect of nominalization on the behavior of nominal, inflation-linked, and real interest rates, and its subsequent effects on the financial market. We find that nominalization has made nominal interest rates less volatile, while the opposite holds for inflation-linked interest rates. The effect on real interest rates is less unambiguous, but nominalization appears to have increased the cost of borrowing.

Original languageEnglish
Pages (from-to)678-709
Number of pages32
JournalQuarterly Review of Economics and Finance
Issue number5 SPEC.ISS.
StatePublished - Dec 2004


  • ICSS algorithm
  • Inflation risk
  • Multivariate GARCH models
  • Nominalization


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