Real Interest Rates and Inflation: An Ex-Ante Empirical Analysis





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    • * Kandel and Sarig are from Tel Aviv University and the Wharton School of the University of Pennsylvania. Ofer is from Tel Aviv University and the Kellogg School at Northwestern University. Financial support for this study was provided by the Israel Institute of Business Research and the Pinhas Sapir Center for Development at Tel-Aviv University. We would like to thank the Editor, René Stulz, Avraham Beja, Jonathan Berk, Sanjai Bhagat, Karen Lewis, William Schwert, Daniel Yariv, and seminar participants at Bank of Israel, Columbia University, Northwestern University, Stanford University, Tel Aviv University, University of California, Berkeley, University of California, Irvine, University of Chicago, University of Pennsylvania, Washington University, Western Finance Association meetings in Santa Fe, and the Winter Conference at the University of Utah for comments and suggestions.


We develop a method of measuring ex-ante real interest rates using prices of index and nominal bonds. Employing this method and newly available data, we directly test the Fisher hypothesis that the real rate of interest is independent of inflation expectations. We find a negative correlation between ex-ante real interest rates and expected inflation. This contradicts the Fisher hypothesis but is consistent with the theories of Mundell and Tobin, Darby and Feldstein, and Stulz. We also find that nominal interest rates include an inflation risk premium that is positively related to a proxy for inflation uncertainty.