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The Term Structure of Interest Rates in the European Union

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  • Minoas Koukouritakis

    ()
    (Department of Economics, University of Crete)

  • Leo Michelis

    (Department of Economics, Ryerson University, Toronto, Canada)

Abstract

This paper uses cointegration and common trends techniques to investigate empirically the expectations hypothesis of the term structure of interest rates among the original 15 EU countries. By decomposing each term structure into its transitory and permanent components, we also examine whether the short or the long rate is weakly exogenous and thus determine the long run behavior of each term structure. The empirical results support the expectations theory of the term structure of interest rates for all the EU-15 countries. They also indicate that the long term interest rates are weakly exogenous for almost all the countries in our sample. Further, we investigate if the expectation theory of the term structure of interest rates is affected by other exogenous variables such as nominal and real exchange rates, inflation rates, inflation variance, money growth and its variance. Our evidence suggests that the inclusion of the other exogenous variables does not affect the expectations hypothesis for most of the EU-15 countries.

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File URL: http://economics.soc.uoc.gr/wpa/docs/Koukouritakis_Michelis_EU15_Term_Structure.pdf
File Function: First version, 2006
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Bibliographic Info

Paper provided by University of Crete, Department of Economics in its series Working Papers with number 0611.

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Length: 46 pages
Date of creation: May 2006
Date of revision:
Handle: RePEc:crt:wpaper:0611

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Keywords: Term Structure; European Union; Cointegration; Common Trends; Weak Exogeneity;

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  1. Pesaran, M. H. & Shin, Y. & Smith, R. J., 1997. "Structural Analysis of Vector Error Correction Models with Exogenous I(1) Variables," Cambridge Working Papers in Economics 9706, Faculty of Economics, University of Cambridge.
  2. Arturo Estrella & Frederic S. Mishkin, 1995. "Predicting U.S. Recessions: Financial Variables as Leading Indicators," NBER Working Papers 5379, National Bureau of Economic Research, Inc.
  3. Gonzalo, J. & Granger, C., 1992. "Estimation of Common Long-Memory Components in Cointegrated Systems," Papers 4, Boston University - Department of Economics.
  4. Mackinnon, J.G. & Haug, A.A. & Michelis, L., 1996. "Numerical Distribution Functions of Likelihood Ratio Tests for Cointegration," G.R.E.Q.A.M. 96a09, Universite Aix-Marseille III.
  5. Arturo Estrella & Gikas A. Hardouvelis, 1989. "The term structure as a predictor of real economic activity," Research Paper 8907, Federal Reserve Bank of New York.
  6. Shiller, Robert J. & Huston McCulloch, J., 1990. "The term structure of interest rates," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 13, pages 627-722 Elsevier.
  7. Holmes, Mark J & Pentecost, Eric J, 1997. "The Term Structure of Interest Rates and Financial Integration in the ERM," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 2(3), pages 237-47, July.
  8. Jurgen Wolters, 1998. "Cointegration and German bond yields," Applied Economics Letters, Taylor & Francis Journals, vol. 5(8), pages 497-502.
  9. 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.
  10. Stefan Gerlach & Frank Smets, 1995. "The term structure of Euro-rates: some evidence in support of the expectations hypothesis," BIS Working Papers 28, Bank for International Settlements.
  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. repec:nbr:nberwo:2341 is not listed on IDEAS
  13. Jondeau, Eric & Ricart, Roland, 1999. "The expectations hypothesis of the term structure: tests on US, German, French, and UK Euro-rates," Journal of International Money and Finance, Elsevier, vol. 18(5), pages 725-750, October.
  14. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
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