Modelling Volatility of Short-term Interest Rates in Kenya
Abstract
There is an extensive theoretical and empirical literature that documents the link between
short-term interest rate volatility and interest rate levels. This study sought to establish the
link between the level of interest and the volatility of interest rates in Kenya using the
Treasury bill rates from August 1991 to December 2007. The main variable for the study
was the short term interest rate series. In Kenya, this is the Central Bank three-month
Treasury bill rate.
The interest rate volatility was studied using the general specification for the stochastic
behaviour of interest rates which is nested in a Stochastic Differential Equation (SDE) for
the instantaneous risk free rate of interest as earlier defined by Chan et al. (1992). The
study applied the monthly averages of the 91-day T-BILL rate for the period between
August 1991 and December 2007 which were obtained from the Central Bank of Kenya.
The results of the study were consistent with the hypothesis that the volatility is positively
correlated with the level of the short term interest rate as documented by previous
empirical studies.
The key findings revealed that there exists a link between the level of short-term interest
rates and volatility of interest rates in Kenya. Secondly, the study‟s key findings revealed
that the GARCH model is better suited for modelling volatility of short rates in Kenya, as
opposed to ARCH models. The study further establishes that GARCH models are able to
capture the very important volatility clustering phenomena that has been documented in
many financial time series, including short-term interest rates. The study recommends
future research to examine if other forms of the GARCH process can produce similar
results (i.e., EGARCH, PGARCH, GARCH, and FIGARCH).
Publisher
University of Nairobi
Description
MBA Thesis