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Non-Linear Error Correction: Evidence for UK Interest Rates

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  • David G. McMillan
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    Abstract

    Recent empirical finance research has suggested the potential for series to exhibit non-linear adjustment to equilibrium. This paper examines a variety of such models and compares their performance with the linear alternative. Using short- and long-term UK interest rates we report evidence that a logistic smooth transition error-correction model is best able to characterize the data and to provide superior out-of-sample forecasts over both linear and non-linear alternatives. This model suggests that market dynamics differ depending on whether the deviations from long-run equilibrium are above or below the threshold value. Further, the logistic smooth transition model indicates that agents' actions imply quicker reversion to equilibrium when the long rate exceeds the short rate, and supports a central bank inflation targeting interpretation of the non-linearity. Copyright Blackwell Publishing Ltd and The Victoria University of Manchester, 2004..

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    Bibliographic Info

    Article provided by University of Manchester in its journal The Manchester School.

    Volume (Year): 72 (2004)
    Issue (Month): 5 (09)
    Pages: 626-640

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    Handle: RePEc:bla:manchs:v:72:y:2004:i:5:p:626-640

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    Cited by:
    1. Samuel S Jibao & Niek Schoeman & Ruthira Naraidoo, 2010. "Fiscal Regime Changes and the Sustainability of Fiscal Imbalance in South Africa: A Smooth Transition Error-Correction Approach," Working Papers 201023, University of Pretoria, Department of Economics.
    2. Ahmad Zubaidi Baharumshah & Venus Khim-Sen Liew & Chan Tze Haw, 2009. "The Real Interest Rate Differential: International Evidence Based On Non-Linear Unit Root Tests," Bulletin of Economic Research, Wiley Blackwell, vol. 61(1), pages 83-94, 01.
    3. Liu, Lin & Chang, Hsu-Ling & Su, Chi-Wei & Jiang, Chun, 2013. "Real interest rate parity in East Asian countries based on China with flexible Fourier stationary test," Japan and the World Economy, Elsevier, vol. 25, pages 52-58.

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