Cointegration in interest rate futures trading on the Sydney future exchange

Abstract

The term structure of interest rates defined by the yields on interest rate futures contracts on 90 day bank bills, ranging in delivery periods from the near quarter month up to five quarters ahead, is examined using unit roots and cointegration tests. Since cointegration indicates a causal relationship, its existence implies an opportunity for profitable forecasting technique. A cointegrated yield series is also inconsistent with the notion of a weakly efficient bill futures market. Although the spreads between the futures yields are shown to be stationary, they do not belong to the cointegrating space. Granger's representation theorem is then applied to identify the error-correction models for these bill futures yield data. The performance of the error-correction model in forecasting out-of-sample futures yield is compared with that of a naive (no change) model. In terms of root mean squared error (RMSE) the error-correction models show modest improvement relative to the naive forecast. It is further sh...