The Causality Effects of the Federal Reserve's Monetary Policy on U.S. and Eurodollar Interest Rates

Abstract

AbstractPrevious studies argue that U.S. interest rates will become more sensitive to changes in eurodollar rates as international financial‐market integration increases. However, the empirical results of these studies are suspect because they select their subperiods in an ad hoc manner and ignore the different trading hours of the U.S. and London markets.This study adjusts for the markets' different trading hours and uses Goldfeld and Quandt's switching regression technique to show that the causal relation between U.S. CD rates and eurodollar rates is impacted by the Federal Reserve's monetary policy. Because the latest subperiod exhibits uni‐directional causality (i.e., U.S. interest rates cause changes in eurodollar rates), the results cast doubt on the implicit assumption made in the literature that interest‐rate causality is only affected by increasing levels of financial‐market integration.