Journal of Statistical and Econometric Methods

Single Factor Interest Rate Models in Inflation Targeting Economies of Emerging Asia

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• Abstract

  Based on two single factor interest rate models of Vasicek and Cox Ingersoll Ross, the divergence in speed of mean reversion and the accompanying instantaneous volatility effect in inflation targeting economies of Emerging Asia are evident. A higher degree of undershoot and overshoot risk of inflation target, for economies such as Indonesia and the Philippines has been identified. The effectiveness of monetary policy erodes as it departs from the objective of central banks and financial regulators. In an environment of weak mean reversion of interest rates that is subject to external shocks, distortion in financial market related interest rate could be severe for Indonesia and the Philippines.