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Modelling interest rates with a cointegrated VAR-GARCH model

  • BAUWENS, Luc

    ()

    (Center for Operations Research and Econometrics (CORE), Université catholique de Louvain (UCL), Louvain la Neuve, Belgium)

  • DEPRINS, Dominique

    (Facultés Universitaires Saint-Louis, Brussels, and Institut de Statistique, Université catholique de Louvain (UCL), Louvain la Neuve, Belgium)

  • VANDEUREN, Jean-Pierre

    (Département de Mathématique, Université catholique de Louvain (UCL), Louvain la Neuve, Belgium)

We use a bivariate VAR model to model and predict the joint evolution of short term and long term interest rates. We introduce a GARCH effect on the innovations of the model in order to account for the changing volatility of the series. We test the cointegration of the two interest rates, which is implied by a present value relation between the rates. The cointegration test is done both with and without taking account of the GARCH effect. The empirical results for five countries (Belgium, Germany, France, Great Britain and the USA) point to the same conclusions: i) the incorporation of the GARCH part allows to conclude more clearly that a cointegration relation exists; ii) GARCH effects are quite present; and iii) the models are useful for short term predictions of interest rates.

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File URL: http://alfresco.uclouvain.be/alfresco/download/attach/workspace/SpacesStore/98206230-1091-4756-a679-7b07639a84dc/coredp_1997_80.pdf
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Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 1997080.

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Date of creation: 01 Oct 1997
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Handle: RePEc:cor:louvco:1997080
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  1. Kim, Kiwhan & Schmidt, Peter, 1993. "Unit root tests with conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 59(3), pages 287-300, October.
  2. Caner, Mehmet, 1998. "Tests for cointegration with infinite variance errors," Journal of Econometrics, Elsevier, vol. 86(1), pages 155-175, June.
  3. John Y. Campbell & Robert J. Shiller, 1986. "Cointegration and Tests of Present Value Models," NBER Working Papers 1885, National Bureau of Economic Research, Inc.
  4. Cheung, Yin-Wong & Lai, Kon S, 1993. "Finite-Sample Sizes of Johansen's Likelihood Ration Tests for Conintegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(3), pages 313-28, August.
  5. Johansen, Soren, 1995. "Likelihood-Based Inference in Cointegrated Vector Autoregressive Models," OUP Catalogue, Oxford University Press, number 9780198774501, March.
  6. Thomas J. Sargent, 1978. "A note on maximum likelihood estimation of the rational expectations model of the term structure," Staff Report 26, Federal Reserve Bank of Minneapolis.
  7. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
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