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Modelling interest rates with a cointegrated VAR-GARCH model

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Author Info

  • BAUWENS, Luc

    ()
    (Center for Operations Research and Econometrics (CORE), Université catholique de Louvain (UCL), Louvain la Neuve, Belgium)

  • DEPRINS, Dominique

    (Facultés Universitaires Saint-Louis, Brussels, and Institut de Statistique, Université catholique de Louvain (UCL), Louvain la Neuve, Belgium)

  • VANDEUREN, Jean-Pierre

    (Département de Mathématique, Université catholique de Louvain (UCL), Louvain la Neuve, Belgium)

Abstract

We use a bivariate VAR model to model and predict the joint evolution of short term and long term interest rates. We introduce a GARCH effect on the innovations of the model in order to account for the changing volatility of the series. We test the cointegration of the two interest rates, which is implied by a present value relation between the rates. The cointegration test is done both with and without taking account of the GARCH effect. The empirical results for five countries (Belgium, Germany, France, Great Britain and the USA) point to the same conclusions: i) the incorporation of the GARCH part allows to conclude more clearly that a cointegration relation exists; ii) GARCH effects are quite present; and iii) the models are useful for short term predictions of interest rates.

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File URL: http://alfresco.uclouvain.be/alfresco/download/attach/workspace/SpacesStore/98206230-1091-4756-a679-7b07639a84dc/coredp_1997_80.pdf
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Bibliographic Info

Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 1997080.

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Date of creation: 01 Oct 1997
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Handle: RePEc:cor:louvco:1997080

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Web page: http://www.uclouvain.be/core
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  1. John Y. Campbell & Robert J. Shiller, 1986. "Cointegration and Tests of Present Value Models," Cowles Foundation Discussion Papers 785, Cowles Foundation for Research in Economics, Yale University.
  2. Cheung, Yin-Wong & Lai, Kon S, 1993. "Finite-Sample Sizes of Johansen's Likelihood Ration Tests for Conintegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(3), pages 313-28, August.
  3. Sargent, Thomas J., 1979. "A note on maximum likelihood estimation of the rational expectations model of the term structure," Journal of Monetary Economics, Elsevier, vol. 5(1), pages 133-143, January.
  4. Caner, Mehmet, 1998. "Tests for cointegration with infinite variance errors," Journal of Econometrics, Elsevier, vol. 86(1), pages 155-175, June.
  5. Johansen, Soren, 1995. "Likelihood-Based Inference in Cointegrated Vector Autoregressive Models," OUP Catalogue, Oxford University Press, number 9780198774501.
  6. Kim, Kiwhan & Schmidt, Peter, 1993. "Unit root tests with conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 59(3), pages 287-300, October.
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Cited by:
  1. Ge, Yuanlong & Wang, H. Holly & Ahn, Sung K., 2008. "Implication of Cotton Price Behavior on Market Integration," 2008 Conference, April 21-22, 2008, St. Louis, Missouri 37623, NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
  2. J. Isaac Miller & Yoosoon Chang & Joon Y. Park, 2005. "Extracting a Common Stochastic Trend:Theories with Some Applications," Working Papers 0507, Department of Economics, University of Missouri, revised 18 Aug 2005.
  3. Lengwiler, Yvan & Lenz, Carlos, 2010. "Intelligible factors for the yield curve," Journal of Econometrics, Elsevier, vol. 157(2), pages 481-491, August.
  4. Chang, Yoosoon & Isaac Miller, J. & Park, Joon Y., 2009. "Extracting a common stochastic trend: Theory with some applications," Journal of Econometrics, Elsevier, vol. 150(2), pages 231-247, June.

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