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Fractional Cointegration Analysis of Long Term International Interest Rates

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  • John Barkoulas

    ()
    (Boston College)

  • Christopher F. Baum

    ()
    (Boston College)

  • Gurkan S. Oguz

    (Tufts University)

Abstract

DeGennaro, Kunkel, and Lee (1994) studied the long run dynamics of a system of long term interest rates of five industrialized countries by means of sophisticated cointegration methods. They found little evidence in support of the cointegration hypothesis, thus concluding that a separate set of fundamentals drives the dynamics of each of the individual long term interest rate series. In this study, we extend their analysis by exploring the possibility of very slow mean reverting dynamics (fractional cointegration) in the system of the five long term interest rates. We use the GPH test as our testing methodology for fractional integration and cointegration. Through rigorous investigation of the full system of the five long term interest rate series and its various subsystems, we provide evidence that the error correction term follows a fractionally integrated process with long memory, that is, it is mean reverting, though not covariance stationary. Despite significant persistence in the short run, a shock to the system of long term interest rates eventually dissipates so that an equilibrium relationship prevails in the long run.

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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 315..

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Length: 29 pages
Date of creation: 01 Jan 1996
Date of revision:
Publication status: published, International Journal of Finance, 1997, 9:2, 586-606.
Handle: RePEc:boc:bocoec:315

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Keywords: long term interest rates; fractional cointegration; long memory;

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References

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  1. 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.
  2. Mbodja Mougoué, 1992. "The Term Structure Of Interest Rates As A Cointegrated System: Empirical Evidence From The Eurocurrency Market," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 15(3), pages 285-296, 09.
  3. Baillie, Richard T & Bollerslev, Tim, 1989. " Common Stochastic Trends in a System of Exchange Rates," Journal of Finance, American Finance Association, vol. 44(1), pages 167-81, March.
  4. Diebold, Francis X. & Rudebusch, Glenn D., 1991. "On the power of Dickey-Fuller tests against fractional alternatives," Economics Letters, Elsevier, vol. 35(2), pages 155-160, February.
  5. Denis Kwiatkowski & Peter C.B. Phillips & Peter Schmidt, 1991. "Testing the Null Hypothesis of Stationarity Against the Alternative of a Unit Root: How Sure Are We That Economic Time Series Have a Unit Root?," Cowles Foundation Discussion Papers 979, Cowles Foundation for Research in Economics, Yale University.
  6. Banerjee, Anindya, et al, 1986. "Exploring Equilibrium Relationships in Econometrics through Static Models: Some Monte Carlo Evidence," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 48(3), pages 253-77, August.
  7. Phillips, P C B, 1987. "Time Series Regression with a Unit Root," Econometrica, Econometric Society, vol. 55(2), pages 277-301, March.
  8. Sims, Christopher A., 1988. "Bayesian skepticism on unit root econometrics," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 463-474.
  9. Diebold, Francis X & Gardeazabal, Javier & Yilmaz, Kamil, 1994. " On Cointegration and Exchange Rate Dynamics," Journal of Finance, American Finance Association, vol. 49(2), pages 727-35, June.
  10. DeGennaro, Ramon P & Kunkel, Robert A & Lee, Junsoo, 1994. "Modeling International Long-Term Interest Rates," The Financial Review, Eastern Finance Association, vol. 29(4), pages 577-97, November.
  11. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
  12. Baillie, R.T. & Bollerslev, T., 1993. "Cointegration, Fractional Cointegration, and Exchange RAte Dynamics," Papers 9103, Michigan State - Econometrics and Economic Theory.
  13. Granger, Clive W J, 1986. "Developments in the Study of Cointegrated Economic Variables," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 48(3), pages 213-28, August.
  14. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
  15. Cheung, Yin-Wong & Lai, Kon S, 1993. "A Fractional Cointegration Analysis of Purchasing Power Parity," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(1), pages 103-12, January.
  16. Mougoue, Mbodja, 1992. "The Term Structure of Interest Rates as a Cointegrated System: Empirical Evidence from the Eurocurrency Market," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 15(3), pages 285-96, Fall.
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Cited by:
  1. S. Lardic & V. Mignon, 2002. "Fractional cointegration and term structure of interest rates," THEMA Working Papers 2002-28, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  2. Stefan C. Norrbin & Aaron D. Smallwood, 2006. "Generalized long memory processes, failure of cointegration tests and exchange rate dynamics," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(4), pages 409-417.
  3. repec:ebl:ecbull:v:3:y:2003:i:14:p:1-10 is not listed on IDEAS
  4. Gael Martin, 2001. "Bayesian Analysis Of A Fractional Cointegration Model," Econometric Reviews, Taylor & Francis Journals, vol. 20(2), pages 217-234.

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