Modelling interest rates with a cointegrated VAR-GARCH model
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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| Date of creation: | 01 Oct 1997 |
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| Handle: | RePEc:cor:louvco:1997080 |
| Contact details of provider: | Postal: Phone: 32(10)474321 Fax: +32 10474304 Web page: http://www.uclouvain.be/coreEmail: More information through EDIRC
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References listed on IDEAS
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- Kim, Kiwhan & Schmidt, Peter, 1993. "Unit root tests with conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 59(3), pages 287-300, October.
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- John Y. Campbell & Robert J. Shiller, 1986. "Cointegration and Tests of Present Value Models," Cowles Foundation Discussion Papers 785, Cowles Foundation for Research in Economics, Yale University.
- 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.
- Johansen, Soren, 1995. "Likelihood-Based Inference in Cointegrated Vector Autoregressive Models," OUP Catalogue, Oxford University Press, number 9780198774501, March.
- Thomas J. Sargent, 1978.
"A note on maximum likelihood estimation of the rational expectations model of the term structure,"
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26, Federal Reserve Bank of Minneapolis.
- Sargent, Thomas J., 1979. "A note on maximum likelihood estimation of the rational expectations model of the term structure," Journal of Monetary Economics, Elsevier, vol. 5(1), pages 133-143, January.
- 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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