Assume That Initially, the Risk Premium, ρ = 0 and That

question 8

Essay

Assume that initially, the risk premium, ρ = 0 and that the domestic and foreign interest rates are given by R = .06, R* = .05. Suppose that the risk premium depends linearly on the difference between domestic government debt, B, and domestic assets of the central bank, A, i.e.
ρ = ρ^(B-A)
Find the new domestic interest rate if a sterilized purchase of foreign assets adjusts A s.t.
(a) B - A = -.01/ ρ_o
(b) B - A = .01/ ρ_o
(c) B - A = .03/ ρ_o

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Definitions:

Observed

Refers to measured or witnessed information and data gathered through experimentation or research.

Expected

Refers to the predicted outcome or value in probability and statistics, often based on theoretical or historical data.

Nonparametric Statistics

Distribution-free statistics that do not require the same assumptions as do parametric statistics.

Distribution-free

Refers to statistical methods that do not rely on assumptions about the specific distribution of the data.