Interest Parity, Cointegration and the Term Structure: Testing in an Integrated Framework
19 Pages Posted: 3 May 2001
Date Written: January 2001
Abstract
In this paper we develop a methodology for testing the validity of the expectations theory of the term structure and the uncovered interest parity within the framework provided by cointegration theory. For this purpose, we apply the multivariate cointegration technique suggested by Johansen (1988, 1991) using data on interest rates from the eurodollar and euromark markets with maturity ranging from 7 days to 1 year. First, we were able to find nine statistically significant cointegrating vectors among the system of ten interest rates. Second, given that more than one long-run relationships were found we imposed independent linear and homogeneous restrictions on the system and the joint structure of the expectations theory and the UIP could not be rejected implying that our proposed framework is a valid framework to study the interdependence of monetary policy in an integrated scheme. Finally, with the application of tests for parameter stability in cointegrated models we show that our cointegration results are sample independent and that the estimated coefficients do not suffer from instabilities in recursive estimations.
Keywords: Cointegration, expectations theory, uncovered interest parity, eurocurrency markets, stability
JEL Classification: F31, F33
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Yield Spreads and Interest Rate Movements: A Bird's Eye View
-
Parsimoneous Modeling of Yield Curves for U.S. Treasury Bills
-
Estimating and Interpreting Forward Interest Rates: Sweden 1992 - 1994
-
Estimating and Interpreting Forward Interest Rates: Sweden 1992-1994
-
The Changing Behavior of the Term Structure of Interest Rates
-
Do We Reject Too Often? Small Sample Properties of Tests of Rational Expectations Models
-
Drawing Inferences from Statistics Based on Multi-Year Asset Returns