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Cointegration, Uncoverd Interest Parity and the Term Structure of Interest Rates: Some International Evidence

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  • Georgoutsos D.
  • Kouretas G.

Abstract

This paper addresses the issue of the empirical investigation of monetary policy independence as this is manifested in the inter–relationships between domestic and foreign money market interest rates. Instead of following an ad–hoc econometric approach, we have imposed a specific economic structure on the proposed model by establishing a link of the yield curves of two different countries through the Uncovered Interest Rate Parity, UIP. The expectations hypothesis of the term structure and the UIP imply certain overidentifying restrictions on the cointegrating space of a vector autoregressive process consisting of the interest rates of the two markets. The model has been tested on data from the domestic US money market and the euromark and euroyen markets. The main finding of our analysis is that we reject the overidentifying restrictions of the models for the USD/DEM case but we are unable to reject them for the USD/JPY case, at the one percent significance level and this implies that the term spreads of the euroyen market are being affected, in the long run, by changes of the US short Fed funds rate.

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Bibliographic Info

Article provided by European Research Studies Journal in its journal European Research Studies Journal.

Volume (Year): V (2002)
Issue (Month): 1-2 (January - June)
Pages: 7-22

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Handle: RePEc:ers:journl:v:v:y:2002:i:1-2:p:7-22

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Related research

Keywords: cointegration; expectations theory; uncovered interest parity; eurocurrency markets; Granger causality;

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  1. Johansen, Soren, 1992. "Determination of Cointegration Rank in the Presence of a Linear Trend," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 383-97, August.
  2. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244.
  3. Jorion, Philippe & Mishkin, Frederic, 1991. "A multicountry comparison of term-structure forecasts at long horizons," Journal of Financial Economics, Elsevier, vol. 29(1), pages 59-80, March.
  4. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  5. Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
  6. Bennett T. McCallum, 1992. "A Reconsideration of the Uncovered Interest Parity Relationship," NBER Working Papers 4113, National Bureau of Economic Research, Inc.
  7. Bruce Kasman & Charles Pigott, 1988. "Interest rate divergences among the major industrial nations," Quarterly Review, Federal Reserve Bank of New York, issue Aut, pages 28-44.
  8. Gerlach, Stefan & Smets, Frank, 1997. "The term structure of Euro-rates: some evidence in support of the expectations hypothesis," Journal of International Money and Finance, Elsevier, vol. 16(2), pages 305-321, April.
  9. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
  10. Hardouvelis, Gikas A., 1994. "The term structure spread and future changes in long and short rates in the G7 countries: Is there a puzzle?," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 255-283, April.
  11. Hall, Anthony D & Anderson, Heather M & Granger, Clive W J, 1992. "A Cointegration Analysis of Treasury Bill Yields," The Review of Economics and Statistics, MIT Press, vol. 74(1), pages 116-26, February.
  12. Fung, Hung-Gay & Isberg, Steven C., 1992. "The international transmission of eurodollar and US interest rates: A cointegration analysis," Journal of Banking & Finance, Elsevier, vol. 16(4), pages 757-769, August.
  13. Levin, Jay H, 1974. "A Financial Sector Analysis of the Eurodollar Market," Journal of Finance, American Finance Association, vol. 29(1), pages 103-17, March.
  14. Juselius, Katarina, 1995. "Do purchasing power parity and uncovered interest rate parity hold in the long run? An example of likelihood inference in a multivariate time-series model," Journal of Econometrics, Elsevier, vol. 69(1), pages 211-240, September.
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