IDEAS home Printed from https://ideas.repec.org/a/eee/finana/v46y2016icp281-294.html
   My bibliography  Save this article

Interest parity, cointegration, and the term structure: Testing in an integrated framework

Author

Listed:
  • Georgoutsos, Dimitris A.
  • Kouretas, Georgios P.

Abstract

In this paper, we develop a methodology for testing jointly the validity of the expectations hypothesis of the term structure (EHTS) and the uncovered interest rate parity (UIRP) within the framework provided by cointegration theory. For this purpose, we use data on interest rates from the U.S. dollar-Libor, GBP-Libor, and Euro-Libor markets with maturities ranging from 7days to 12months. The main findings of our analysis are as follows: (i) we fail to find the correct rank of the cointegration space suggested by our methodology; (ii) with the application of tests for parameter stability in cointegrated models, we show that our cointegration results are sample independent and that the estimated coefficients do not suffer from instabilities in recursive estimations; (iii) from the moving average representation of the model, we estimate the common stochastic trends whose components establish, in the USD/Euro case, the interdependence of interest rates in the formation of the driving forces of the system; (iv) we manage to identify with the two theories a sub-space of the estimated cointegration space.

Suggested Citation

  • Georgoutsos, Dimitris A. & Kouretas, Georgios P., 2016. "Interest parity, cointegration, and the term structure: Testing in an integrated framework," International Review of Financial Analysis, Elsevier, vol. 46(C), pages 281-294.
  • Handle: RePEc:eee:finana:v:46:y:2016:i:c:p:281-294
    DOI: 10.1016/j.irfa.2015.12.001
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1057521915002112
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. MacKinnon, James G & Haug, Alfred A & Michelis, Leo, 1999. "Numerical Distribution Functions of Likelihood Ratio Tests for Cointegration," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 14(5), pages 563-577, Sept.-Oct.
    2. Campbell, John Y & Shiller, Robert J, 1987. "Cointegration and Tests of Present Value Models," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 1062-1088, October.
    3. Michael Ehrmann & Marcel Fratzscher & Refet S Güürkaynak & Eric T Swanson, 2011. "Convergence and Anchoring of Yield Curves in the Euro Area," The Review of Economics and Statistics, MIT Press, vol. 93(1), pages 350-364, February.
    4. Elliott, Graham, 1999. "Efficient Tests for a Unit Root When the Initial Observation Is Drawn from Its Unconditional Distribution," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(3), pages 767-783, August.
    5. Bekaert, Geert & Wei, Min & Xing, Yuhang, 2007. "Uncovered interest rate parity and the term structure," Journal of International Money and Finance, Elsevier, vol. 26(6), pages 1038-1069, October.
    6. 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.
    7. Doornik, Jurgen A & Hendry, David F & Nielsen, Bent, 1998. " Inference in Cointegrating Models: UK M1 Revisited," Journal of Economic Surveys, Wiley Blackwell, vol. 12(5), pages 533-572, December.
    8. Henrik Hansen & Søren Johansen, 1999. "Some tests for parameter constancy in cointegrated VAR-models," Econometrics Journal, Royal Economic Society, vol. 2(2), pages 306-333.
    9. Joseph Bisignano, 1983. "Monetary policy regimes and international term structures of interest rates," Working Papers in Applied Economic Theory 83-02, Federal Reserve Bank of San Francisco.
    10. Perron, Pierre & Rodriguez, Gabriel, 2003. "GLS detrending, efficient unit root tests and structural change," Journal of Econometrics, Elsevier, vol. 115(1), pages 1-27, July.
    11. Phillips, P C B, 1987. "Time Series Regression with a Unit Root," Econometrica, Econometric Society, vol. 55(2), pages 277-301, March.
    12. Joseph Bisignano, 1983. "Monetary policy regimes and international term structures of interest rates," Economic Review, Federal Reserve Bank of San Francisco, issue Fall, pages 7-26.
    13. Cuthbertson, Keith & Hayes, Simon & Nitzsche, Dirk, 1998. "Interest Rates in Germany and the UK: Cointegration and Error Correction Models," The Manchester School of Economic & Social Studies, University of Manchester, vol. 66(1), pages 27-43, January.
    14. Carstensen, Kai, 2003. "Nonstationary term premia and cointegration of the term structure," Economics Letters, Elsevier, vol. 80(3), pages 409-413, September.
    15. Michael Ehrmann & Marcel Fratzscher, 2005. "Equal Size, Equal Role? Interest Rate Interdependence Between the Euro Area and the United States," Economic Journal, Royal Economic Society, vol. 115(506), pages 928-948, October.
    16. Evans, Martin D. D. & Lewis, Karen K., 1994. "Do stationary risk premia explain it all?: Evidence from the term structure," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 285-318, April.
    17. Paul Boothe, 1991. "Interest Parity, Cointegration, and the Term Structure in Canada and the United States," Canadian Journal of Economics, Canadian Economics Association, vol. 24(3), pages 595-603, August.
    18. 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 237-247, July.
    19. Phillips, P C B, 1987. "Time Series Regression with a Unit Root," Econometrica, Econometric Society, vol. 55(2), pages 277-301, March.
    20. Kugler, Peter, 2000. "The expectations hypothesis of the term structure of interest rates, open interest rate parity and central bank policy reaction," Economics Letters, Elsevier, vol. 66(2), pages 209-214, February.
    21. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-1580, November.
    22. Paul R. Krugman, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 669-682.
    23. Elliott, Graham & Rothenberg, Thomas J & Stock, James H, 1996. "Efficient Tests for an Autoregressive Unit Root," Econometrica, Econometric Society, vol. 64(4), pages 813-836, July.
    24. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
    25. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244.
    26. Johansen, Soren, 1995. "Identifying restrictions of linear equations with applications to simultaneous equations and cointegration," Journal of Econometrics, Elsevier, vol. 69(1), pages 111-132, September.
    27. Johansen, Soren & Juselius, Katarina, 1994. "Identification of the long-run and the short-run structure an application to the ISLM model," Journal of Econometrics, Elsevier, vol. 63(1), pages 7-36, July.
    28. Siklos, Pierre L. & Wohar, Mark E., 1996. "Cointegration and the term structure: A multicountry comparison," International Review of Economics & Finance, Elsevier, vol. 5(1), pages 21-34.
    29. Jaya Krishnakumar & David Neto, 2012. "Testing Uncovered Interest Rate Parity and Term Structure Using a Three‐regime Threshold Unit Root VECM: An Application to the Swiss ‘Isle’ of Interest Rates," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 74(2), pages 180-202, April.
    30. 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 116-126, February.
    31. James H. Stock & Mark W. Watson, 2012. "Disentangling the Channels of the 2007-09 Recession," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 44(1 (Spring), pages 81-156.
    32. James H. Stock & Mark W. Watson, 2012. "Disentangling the Channels of the 2007-2009 Recession," NBER Working Papers 18094, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Cointegration; Expectations theory; Uncovered interest parity; Eurocurrency markets; Temporal stability;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:finana:v:46:y:2016:i:c:p:281-294. 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: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/inca/620166 .

    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 CitEc recognized a reference but did not link an item in RePEc 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 RePEc Author Service 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.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.