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Fractional Integration and Cointegration: Testing the Term Structure of Interest Rates

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  • Marco R Barassi
  • Dayong Zhang

Abstract

The expectation hypothesis suggests there exists long run equilibrium of interest rate term structure. Two theoretical approaches proposed by Campbell and Shiller (1987) and Hall el al. (1992) suggest that the term spread of long-term and short-term interest rates should be a stationary I(0) process. However, an empirically non stationary term spread or rejection of cointegration between long and short interest rates, in the traditional sense need not to be considered against the simple theoretical model. It is likely that the dichotomy between I(1) or I(0) and/or integer values of cointegration are environments which are too restrictive to model the term structure. In this paper, we evaluate and apply some recent techniques on testing fractional integration and propose the use of a residual based approach which uses the Exact Local Whittle Estimator. The method is then used to investigate the term structure in the UK and the US.

Suggested Citation

  • Marco R Barassi & Dayong Zhang, 2009. "Fractional Integration and Cointegration: Testing the Term Structure of Interest Rates," Discussion Papers 09-17, Department of Economics, University of Birmingham.
  • Handle: RePEc:bir:birmec:09-17
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    References listed on IDEAS

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    Cited by:

    1. Guglielmo Maria Caporale & Luis Alberiko Gil-Alana, 2012. "Fractional cointegration in US term spreads," Applied Economics Letters, Taylor & Francis Journals, vol. 19(5), pages 431-434, March.

    More about this item

    Keywords

    Term Structure; Long Memory; Fractional Integration; Fractional Cointegration; Local Whittle Estimation;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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