Advanced Search
MyIDEAS: Login to save this paper or follow this series

The Cointegration of International Interest rates

Contents:

Author Info

  • Devine, Máiréad

    (Central Bank and Financial Services Authority of Ireland)

Registered author(s):

    Abstract

    Cointegration is a new way of looking at the relationship between economic variables. If rNL and rDE are interest rates on the same instrument in the Netherlands and Germany respectively we would expect that they would be the same i.e. (1) rNL - rDE = 0 At any instant in time there may be a differential between the two interest rates i.e. (2) rNL - rDE = d If the action of the market through arbitrage or other processes tends to reduce d towards zero, whenever a non-zero d arises, the process will tend to move towards the relationship (1), even though (1) may never hold exactly. A relationship of this form is known as a cointegrating (or equilibrium) relationship. Such relationships may take many forms, may involve more than two variables and are often found in economics. The present analysis concerns the forms of cointegrating relationships that hold between international interest rates and the conclusions that can be drawn as regards the international convergence of interest rates. In a risk-free world with fixed exchange rates and perfect capital mobility interest rates will be the same in all countries. Any variations that occur will tend to vanish after a period of time. This equality of interest rates will define an equilibrium or cointegrating relationship between them. In a less than perfect world there can be other cointegrating equilibrium relationships. In Bretton Woods days, for example, the interest rate differential will have been determined mainly by capital controls and tended to some constant value. In such cases modern statistical analysis would have found equilibrium or cointegrating relationships even though interest rates had not converged. If we consider a period of time made up of three parts - the first in which such cointegrating relationships held and the second a time of transition to a third in which interest rates had converged. In this instance there is no unique equilibrium relation between the interest rates over the extended period and statistical analysis should fail to find a cointegrating relationship. Thus, the interpretation of findings of cointegration between interest rates does not imply convergence to zero differentials. The existence of convergence from one equilibrium with non-zero differentials to one with revised differentials implies that cointegration tests should fail. If we are living in a world of increasing financial liberalisation and harmonisation of world economies, then it is likely that such equilibrium relationships are changing and that we will not be able to find cointegration even though there may be a tendency to converge. The literature which has been reviewed in this regard has not addressed the points raised in the above discussion. Hence, it is not surprising that the results of the empirical evidence reviewed have presented divergent and sometimes ambiguous results. The relevance of international interest rate linkages to macroeconomic policy implementation suggests that the cointegration of long and short interest rates across boundaries warrants further attention.

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://www.centralbank.ie/publications/documents/1RT97.pdf
    Download Restriction: no

    Bibliographic Info

    Paper provided by Central Bank of Ireland in its series Research Technical Papers with number 1/RT/97.

    as in new window
    Length: 25 pages
    Date of creation: Jan 1997
    Date of revision:
    Handle: RePEc:cbi:wpaper:1/rt/97

    Contact details of provider:
    Postal: P.O. Box No. 559, Dame Street, Dublin 2
    Phone: (01) 671 6666
    Fax: (01) 671 6561
    Email:
    Web page: http://www.centralbank.ie
    More information through EDIRC

    Related research

    Keywords:

    References

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. Cumby, Robert E. & Mishkin, Frederic S., 1986. "The international linkage of real interest rates: The European-US connection," Journal of International Money and Finance, Elsevier, Elsevier, vol. 5(1), pages 5-23, March.
    2. Kirchgassner, Gebhard & Wolters, Jurgen, 1995. "Interest Rate Linkages in Europe before and after the Introduction of the European Monetary System: Some Empirical Results," Empirical Economics, Springer, Springer, vol. 20(3), pages 435-54.
    3. Morris Goldstein & Michael Mussa, 1993. "The Integration of World Capital Markets," IMF Working Papers 93/95, International Monetary Fund.
    4. Taylor, Mark P, 1989. "Covered Interest Arbitrage and Market Turbulence," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 99(396), pages 376-91, June.
    5. Karfakis, Costas J & Moschos, Demetrios M, 1990. "Interest Rate Linkages within the European Monetary System: A Time Series Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 22(3), pages 389-94, August.
    6. Karsten Biltoft & Christian Boersch, 1992. "Interest rate causality and asymmetry in the EMS," Open Economies Review, Springer, Springer, vol. 3(3), pages 297-306, October.
    7. Katsimbris, George M & Miller, Stephen M, 1993. "Interest Rate Linkages within the European Monetary System: Further Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 25(4), pages 771-79, November.
    8. Perron, Pierre, 1989. "The Great Crash, the Oil Price Shock, and the Unit Root Hypothesis," Econometrica, Econometric Society, Econometric Society, vol. 57(6), pages 1361-1401, November.
    9. Shinji Takagi, 1991. "Exchange Rate Expectations: A Survey of Survey Studies," IMF Staff Papers, Palgrave Macmillan, vol. 38(1), pages 156-183, March.
    10. Mark, Nelson C., 1985. "Some evidence on the international inequality of real interest rates," Journal of International Money and Finance, Elsevier, Elsevier, vol. 4(2), pages 189-208, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:cbi:wpaper:1/rt/97. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Richard Smith).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.