Nonlinear Dynamics in Term Structure of Interest Rates: Evidence from the Euro Area

Year 2015, Volume: 23 Issue: 26, 79 - 98, 14.10.2015

Ayşen Araç

Abstract

The long run relationship between short term and long term interest rates has drawn much attention since European sovereign debt crisis in 2011-2012. Motivated by this observation, this paper investigates the expectations hypothesis (EH) of term structure of interest rates in the euro area for the 2000:01-2014:04 period. By using the nonlinear cointegration approach developed by Kapetanios et al. (2006), we find that the long run relationship between long term and short term interest rates is stable with nonlinear adjustment. Our results provide evidence in favour of the EH. Moreover, the findings suggest that nonlinear mean reversion effects of the cointegrating residuals increase with the maturity of interest rates.

Keywords

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