Modeling the International Links Between the Dollar, Euro and Yen Interest Rate Swap Markets Through a Multiscaling Approach

This chapter investigates the links between the world’s largest interest rate swap markets, namely the US dollar, the euro and the Japanese yen, over various time horizons through a wavelet multiscaling approach. In contrast to approaches used in previous studies, wavelet analysis allows us to decompose the data into various time scales. First, we investigate the issue of causal relationships across the three major international swap markets using a multiscaling approach. Using this technique, we find that the dynamic causal interactions intensified over time and are persistent after the d3 wavelet time scale, which corresponds to 8–16 trading days. We find that the variances of the dollar and the euro swap markets are high compared to the yen market. We also find that the correlation between swap markets varies over time but remains very high, especially between the dollar and the euro. However, it is much lower between the euro and the yen, and between the dollar and the yen, implying that even though there have been striking developments in international swap markets since 1999, the yen market remains relatively less integrated with the other major swap markets. Finally, there is a noticeable variability in the euro swap market, compared to the dollar and yen swap markets, regardless of the time scale.