What is driving the Capital Inflows to Costa Rica? Risk Premium and Interest Rate Differentials

Leon, Jorge and Vega, Melissa (2013): What is driving the Capital Inflows to Costa Rica? Risk Premium and Interest Rate Differentials.

Abstract

The goal of this paper is to analyse the interest rate differential as the possible main factor behind the capital inflows experienced by Costa Rica during the second semester of 2012. For this purpose, a panel data model for interest rate differential is estimated taking into consideration an array of relevant macroeconomic variables. The results suggest that interest rate differentials for Costa Rica in 2012 are above what the estimated model predicts for the lending rate and deposit rate by 8.4 pp., and between 2.7 p.p. and 1.7 p.p., respectively. This excess in the interest rate differential could explain the observed capital inflows. Therefore, a reduction of lending and deposit interest rate differentials is crucial, but an extra effort has to be made to reduce the lending rate differential. As a consequence of the prevailing situation, the difference between lending and deposit rate in Costa Rica is greater than in countries with similar levels of risk.

• Item Type: MPRA Paper
• Language: English
• Keywords: Interest Rate, Risk Premium, Uncovered Interest Rate Parity
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E50 - General; F - International Economics > F3 - International Finance > F36 - Financial Aspects of Economic Integration; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

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