Short-term eurocurrency rate behavior and specifications of cointegrating processes

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This article presents empirical evidence on short-term behavior based on seven Eurocurrency market rates. Empirical analysis suggests that there is two-dimensional cointegration. First, the domestic short-term interest rate is cointegrated with longer-term interest rates within a particular country. Second, the domestic short-term interest rate is cointegrated with the comparable foreign short-term interest rate adjusted for the foreign exchange forward premium (discount). The empirical evidence confirms that an error-correction model combining both dimensional market-correcting processes better explains short-term interest rate movements.