A Financial Econometric Analysis of the Determinants of Interest Rate Risk in the US

We introduce a macroeconomic system which we use for interest rate determination, after which we generate the interest rate risk premium. Considering this risk premium function, we investigate, test and determine the macro-variables which affect the interest rate risk premia by using a GARCH(p,q) and an ARCH-M model. The empirical results examine ten different interest rate risk premia and fifteen factors. Factors with significant effects on risk premia are: the real risk-free rate of interest, the inflation rate, the unemployment rate, the growth of GDP and industrial production, the growth of national debt and current account deficit, the money supply growth, the yield differentials on S-T and L-T securities and other variables. The conclusion is that, if we can decrease the volatility of the aforementioned determinants, we can also reduce interest rate risk and, consequently, the risk premium, thus, improving social interest.