The Term Structure of Interest Rates in the European Union

This paper uses cointegration and common trends techniques to investigate empirically the expectations hypothesis of the term structure of interest rates among the original 15 EU countries. By decomposing each term structure into its transitory and permanent components, we also examine whether the short or the long rate is weakly exogenous and thus determine the long run behavior of each term structure. The empirical results support the expectations theory of the term structure of interest rates for all the EU-15 countries. They also indicate that the long term interest rates are weakly exogenous for almost all the countries in our sample. Further, we investigate if the expectation theory of the term structure of interest rates is affected by other exogenous variables such as nominal and real exchange rates, inflation rates, inflation variance, money growth and its variance. Our evidence suggests that the inclusion of the other exogenous variables does not affect the expectations hypothesis for most of the EU-15 countries.