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Testing for a flexible non-linear link between short-term Eurorates and spreads

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  • Marcelo Fernandes

Abstract

This paper investigates the relationship between short-term interest rates and spreads in the Euromarket. Specifically, five Eurocurrency deposit rates are analyzed: the Belgian and French francs, the German mark, the Danish crown, and the British pound. A multivariate test for unit roots is performed and strongly rejects the null hypothesis of integration in the 1-month and 12-months rates of these Eurocurrencies, indicating that the spread cannot be seen as a cointegration vector. Notwithstanding, a codependence analysis shows that the spread can still be interpreted as a long-run relationship between the short- and long-term Eurorates. A flexible non-linear error correction model is then proposed for the short-term rate to take both the short- and long-run adjustments into account. The model fits the data quite well, and seems to provide a slightly better forecast accuracy than the random walk benchmark.

Suggested Citation

  • Marcelo Fernandes, 2003. "Testing for a flexible non-linear link between short-term Eurorates and spreads," The European Journal of Finance, Taylor & Francis Journals, vol. 9(2), pages 125-145.
    • Handle: RePEc:taf:eurjfi:v:9:y:2003:i:2:p:125-145
    DOI: 10.1080/13518470110074855
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