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Integration or Independence? An Alternative Assessment of Real Interest Rate Linkages in the European Union

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  • Mark J. Holmes

Abstract

The relationship between national real interest rates provides a valuable insight into the extent of economic and financial integration between countries. This paper tests for long-run parity in ex post real interest rates among the major European Union (EU) countries over the period 1979-2003. The empirical investigation, however, is based on an alternative approach. Strong parity is determined by whether or not the first largest principal component (LPC), based on real interest rate differentials with respect to a chosen base country, is stationary. The qualitative outcome of the test is invariant to the choice of base country, and compared with alternative multivariate tests for long-run parity, this methodology places less demands on limited data sets. Strong evidence of onshore parity occurs during 1979-1990 and 1993-2003 with the half-life of a deviation to parity that varies towards 6 months. There is no evidence of long-run parity among EU members during 1990-1993 despite the easing of remaining capital controls in 1990. Parity is rejected for a sample of non-EU countries throughout the study period. Copyright Banca Monte dei Paschi di Siena SpA, 2005

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  • Mark J. Holmes, 2005. "Integration or Independence? An Alternative Assessment of Real Interest Rate Linkages in the European Union," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 34(3), pages 407-427, November.
  • Handle: RePEc:bla:ecnote:v:34:y:2005:i:3:p:407-427
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    Cited by:

    1. Agénor, Pierre-Richard & Aizenman, Joshua, 2011. "Capital market imperfections and the theory of optimum currency areas," Journal of International Money and Finance, Elsevier, vol. 30(8), pages 1659-1675.
    2. Chan Tze-Haw & Ahmad Zubaidi Baharumshah & Evan Lau, 2007. "Real Financial Integration among the East Asian Economies: A SURADF Panel Approach," Capital Markets Review, Malaysian Finance Association, vol. 15(1&2), pages 53-71.
    3. Baharumshah, Ahmad Zubaidi & Soon, Siew-Voon & Hamzah, Nor Aishah, 2013. "Parity reversion in real interest rate in the Asian countries: Further evidence based on local-persistent model," Economic Modelling, Elsevier, vol. 35(C), pages 634-642.
    4. Mariam Camarero & Josep Lluis Carrion-I-Silvestre & Cecilio Tamarit, 2009. "Testing For Real Interest Rate Parity Using Panel Stationarity Tests With Dependence: A Note," Manchester School, University of Manchester, vol. 77(1), pages 112-126, January.
    5. Arghyrou, Michael G. & Gregoriou, Andros & Kontonikas, Alexandros, 2009. "Do real interest rates converge? Evidence from the European union," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 19(3), pages 447-460, July.
    6. Baharumshah, Ahmad Zubaidi & Soon, Siew-Voon & Boršič, Darja, 2013. "Real interest parity in Central and Eastern European countries: Evidence on integration into EU and the US markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 25(C), pages 163-180.
    7. Ling, Tai-Hu & Liew, Venus Khim-Sen & Syed Khalid Wafa, Syed Azizi Wafa, 2007. "Fisher hypothesis: East Asian evidence from panel unit root tests," MPRA Paper 5432, University Library of Munich, Germany.

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