What happened to the transatlantic capital market relations?
This paper investigates the capital market relations between Euroland and the USA from 1990 until 2006. The UIP-implied long-run relation between European and US government bond yields is shown breaking down in the mid-1990s. However, contrasting with conventional theory, a stationary equilibrium exists additionally including the exchange rate. The reason proves to be a stochastic trend common to the European interest and the euro/dollar rate, which is explained by central bank reactions and unfinished learning processes on the role of the euro. Furthermore, the paper demonstrates a striking reduction in the US capital market dominance, leading to transatlantic interdependence at eye level.
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