Abstract
To signal monetary policies and market expectations, we apply a fractionally cointegrated vector autoregressive (FCVAR) model, aiming to analyse the expectations hypothesis of term structure (EHTS), persistence in the Euro OverNight Index Average (Eonia) spread and permanent-transitory decomposition using a novel approach. We use a monthly frequency sample for the 3- month Euribor rate and Eonia rate, covering the period from January 1999 to February 2019. The results obtained confirm the EHTS and show evidence of a high persistence of the spread, which means that shocks may impede effectiveness in monetary policy and that the European Central Bank (ECB) loses control over interest rates. Additionally, according to permanent-transitory decomposition, we determine that the Eonia rate has a permanent component and thus dominates the common trend in the cointegration system. In sum, if the ECB wants to keep the interbank market interest rates under control, it must contemplate the evolution of the Eonia rate.
Highlights
Interest rates play an important role in the monetary policy defined by central banks, joining the short- and longer-term interest rates to predict the behaviour of the financial markets and the economy
This body of literature has been supported by the expectations hypothesis of term structure (EHTS), which consists of the study of this linkage among overnight rates and short-term rates to explain the monetary policy in the Eurozone, establishing that longer-term interest rates are determined by the expected short-term rates plus a constant term and that both interest rates show a long-run relationship
We can see that both results – those for the Euro OverNight Index Average (Eonia) rate and 3-month Euribor rate – are very similar and in line with the results shown later
Summary
This body of literature has been supported by the EHTS, which consists of the study of this linkage among overnight rates and short-term rates to explain the monetary policy in the Eurozone, establishing that longer-term interest rates are determined by the expected short-term rates plus a constant term and that both interest rates show a long-run relationship Our new approach uses the FCVAR model developed by Søren Johansen and Nielsen (2012) and Nielsen and Popiel (2016), which is an expansion of the traditional cointegrated vector autoregressive (CVAR) model proposed by Johansen (1995), enabling us to establish the number of equilibrium relations via cointegrating rank testing to estimate memory parameters, long-run cointegrating relations with adjustment parameters, and short-run lagged dynamics In this respect, our purpose is to analyse the dynamics of the short-term side of the yield curve, i.e., the relationship between Eonia rate and short-term interbank rates (Euribor rate) as well as the repercussion that the behaviour of the spread between both interest rates may affect the monetary policy and its implications simultaneously. Using PT decomposition, we provide evidence that the interest rate has the dominant position in the common trend
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