Euro-dollar Rate Research Articles

Dynamic linkages between US and Eurodollar interest rates: new evidence from causality in quantiles

Global markets have become more integrated, making co-movements of international interest rates possible. In this paper, we investigate the causal linkage between US and Eurodollar (London) interest rate using the Granger causality test in quantiles. This permits us to examine causality over interest rate distributions not covered by the usual causality test. We therefore test causality in different quantile ranges. A common attribute with previous studies that investigate the causal linkages among interest rates across international money markets is the assumption that the causal relations between international interest rate changes are constant across different interest rate levels. In this study, we allow for asymmetric quantile causal effects. Our empirical results suggest a quantile causal effect between US interest rate and Eurodollar interest rate. US interest rate Granger cause Eurodollar interest rate. The effect is positive at lower quantiles and negative at upper quantiles. On the other hand, Eurodollar interest rate Granger cause US interest rate, but the effect is negative at the lower quantile and positive at the upper quantile. The estimated causality coefficients at both the lower and the higher quantiles are significantly different from the median coefficients.

Dinámica de cointegración en la paridad implícita del eurodólar en la República Dominicana

El presente estudio explora la relación entre la razón del tipo de cambio local peso/euro y peso/dólar, efectivamente una tasa eurodólar implícita, con el eurodólar oficial internacional. Se encontró que el eurodólar implícito local mantiene una relación de equilibrio de largo plazo con su contraparte internacional; cuando existieron desajustes, la velocidad de convergencia promedio se encontraba alrededor de cinco días previo a la implementación del esquema de metas de inflación del Banco Central, mas ahora pasó a ser de alrededor 20 días. Estos resultados reflejan tres condiciones importantes del mercado financiero dominicano actual: primero, existe un vínculo estrecho entre el desenvolvimiento de los mercados globales y el mercado local; segundo, aún existen oportunidades de arbitraje en el corto plazo en el mercado de divisas; y tercero, que la implementación de un régimen de metas de inflación ha tenido un costo en República Dominicana que parece reflejarse a través de cierta rigidez en el mercado cambiario.

Assessing Euro crises from a time varying international CAPM approach

Abstract This paper initially reviews the current empirical literature on the euro exchange rate. We consider the relationship between the euro and other floating currencies in terms of excess returns on bond markets and also the relationship between the euro–dollar and the US and European equity markets. One novelty in the paper is to consider the variation in the euro–dollar rate from an international capital asset pricing model (CAPM) perspective. The second new innovation is to use a kernel weighted time varying parameter regression approach which allows structural parameters and risk premium terms to evolve over time. We find evidence that the euro–dollar rate is substantially influenced by equity markets in the US and in the Eurozone.

Semiparametric Localized Bandwidth Selection in Kernel Density Estimation

Since conventional cross-validation bandwidth selection methods don't work for the case where the data considered are dependent time series, alternative bandwidth selection methods are needed. In recent years, Bayesian based global bandwidth selection methods have been proposed. Our experience shows that the use of a global bandwidth is however less suitable than using a localized bandwidth in kernel density estimation in the case where the data are dependent time series as discussed in an empirical application of this paper. Nonetheless, a difficult issue is how we can consistently estimate a localized bandwidth. In this paper, we propose a semiparametric estimation method, for which we establish an asymptotic theory for the proposed semiparametric estimator. A by-product of this bandwidth estimate is a new sampling-based likelihood approach to hyperparameter estimation. Monte Carlo simulation studies show that the proposed hyperparameter estimation method works very well, and that the proposed bandwidth estimator outperforms its competitors. Applications of the new bandwidth estimator to the kernel density estimation of Eurodollar deposit rate, as well as the S&P 500 daily return under conditional heteroscedasticity, demonstrate the effectiveness and competitiveness of the proposed semiparametric localized bandwidth.

Market Risk of the Fixed Rates Contracts

In this paper we focus on the concept of a discount rate. In [1] one expressed some concerns regarding the models that present randomization of the discount rate. This paper proposed a new approach to the construction of variable deterministic and stochastic interest rates. This approach is based on the concept of forward rate. In [1, 2] we introduced a new analytical model of popular rate LIBOR. This rate is commonly used in the construction of price instruments that include the euro-dollar exchange rate components. LIBOR is by definition is the average deposit rates of the world's major banks. Valuations of the LIBOR is based on survey Alternative construction of the euro-dollar rate contract may use a synthetic approach. This approach follows the model of LIBOR proposed in [1]. The synthetic approach involves the price value, which consists of the price of its constituent components. This interpretation implies that the LIBOR rate to be charged for deposit of one dollar in the risk free Bank at the initial time which then immediately converts it to the British pounds. The resulting amount is invested then in risk-free British bonds for the period of the contract. At the end of this period, cumulated amount is converted back into dollars. Calculated interest rate represents an analytical representation of a dollar deposit to the risk free Bank while LIBOR rate is the average of the top panel of banks. In [2] we synthetically constructed price associated with LIBOR. Hence, the standard modeling of the LIBOR deals with empirical data rather than with its formal definition.

Predicting short-term interest rates using Bayesian model averaging: Evidence from weekly and high frequency data

This paper examines the forecasting performance of Bayesian model averaging (BMA) for a set of single factor models of short-term interest rates. Using weekly and high frequency data for the one-month Eurodollar rate, BMA produces predictive likelihoods that are considerably better than those associated with the majority of the short-rate models, but marginally worse than those of the best model in each dataset. We also find that BMA forecasts based on recent predictive likelihoods are preferred to those based on the marginal likelihood of the entire dataset.

The Impact of Yuan Internationalization on the Euro-Dollar Exchange Rate

We study the implication of a multipolarization of the international monetary system on cross-currency volatility. More specifically, we analyze whether the internationalization of the yuan could modify the impact of asset supply and trade shocks on the euro-dollar exchange rate, within a three-country, three-currency portfolio model. Our static model shows that the internationalization of the yuan (defined as a rise in the yuan in international portfolios) would be either neutral or stabilizing for the euro-dollar rate, whatever the exchange-rate regime of China. Moving to a dynamic, stock-flow framework, we show that the internationalization of the yuan would make exchange-rate variations more efficient to stabilize net foreign asset positions after a trade shock.

Short-Run Forecasting of the Euro-Dollar Exchange Rate with Economic Fundamentals

We propose a fundamentals-based econometric model for the weekly changes in the euro-dollar rate with the distinctive feature of mixing economic variables quoted at different frequencies. The model obtains good in-sample fit and, more importantly, encouraging out-of-sample forecasting results at horizons ranging from one week to one month. Specifically, we obtain statistically significant improvements upon the hard-to-beat random walk model using traditional statistical measures of forecasting error at all horizons. Moreover, our model improves greatly when we use the direction-of-change metric, which has more economic relevance than other loss measures. With this measure, our model performs much better at all forecasting horizons than a naive model that predicts the exchange rate has an equal chance to go up or down, with statistically significant improvements.

Short-run forecasting of the euro-dollar exchange rate with economic fundamentals

We propose a fundamentals-based econometric model for the weekly changes in the euro-dollar rate with the distinctive feature of mixing economic variables quoted at different frequencies. The model obtains good in-sample fit and, more importantly, encouraging out-of-sample forecasting results at horizons ranging from one-week to one month. Specifically, we obtain statistically significant improvements upon the hard-to-beat random-walk model using traditional statistical measures of forecasting error at all horizons. Moreover, our model obtains a great improvement when we use the direction of change metric, which has more economic relevance than other loss measures. With this measure, our model performs much better at all forecasting horizons than a naive model that predicts the exchange rate as an equal chance to go up or down, with statistically significant improvements.

Options on federal funds futures and interest rate volatility

This study examines the response of the spot and futures interest rates on the fed funds, Eurodollar, and Libor to the listing of CME fed funds options. With the exception of the Libor futures, the introduction of options is associated with a decrease in the conditional volatility of the interest rates in the sample. There is also evidence that the volume of options trading has a negative effect on the fed funds and the Eurodollar spot rates. In contrast, the fed funds and the Eurodollar futures rates respond positively to the volume of options trading. Overall, strong generalization of the effects of options listing and options trading across the markets is not possible. These results remain robust even after controlling for several exogenous variables including changes in the Fed's target for the fed funds rate, the TED spread, the 9/11 terrorist attacks, and day-of-the-week effects.

Predicting Short-Term Interest Rates: Does Bayesian Model Averaging Provide Forecast Improvement?

This paper examines the forecasting qualities of Bayesian Model Averaging (BMA) over a set of single factor models of short-term interest rates. Using weekly and high frequency data for the one-month Eurodollar rate, BMA produces predictive likelihoods that are considerably better than the majority of the short-rate models, but marginally worse off than the best model in each dataset. We observe preference for models incorporating volatility clustering for weekly data and simpler short rate models for high frequency data. This is contrary to the popular belief that a diffusion process with volatility clustering best characterizes the short rate.

Evolving Perceptions of Central Bank Credibility: The European Central Bank Experience

What are the preferences of a central bank over inflation and output-gap stabilization objectives, and what is its preferred long-run inflation rate? While statements of priorities and goals are important, the credibility of such statements and the market perception of the policy reaction function of a central bank play a key role in determining economic outcomes. This point, early on described as the “credibility” of central bank policies, is a standard theoretical result with recent interpretation in the New Keynesian paradigms. It is also received wisdom among practitioners. The importance of the market perception of the central bank’s acceptable trade-offs between inflation and output goals as well its specific targets naturally leads to the question of how the market acquires this perception and whether and how it evolves over time. One view is that establishing an appropriate institutional structure is the key element in insulating the monetary authority from political pressure and thereby convincing markets that a central bank has a strong and unvarying aversion to inflation. A second, more dynamic, view focuses on the role that actual policy conduct plays in building the reputation of a central bank. These two different views have distinct implications for the relative importance of the institutional structure of a central bank, as compared to its conduct, for attaining and maintaining its credibility. A survey of the heads of central banks and prominent monetary economists reflects a belief that the credibility of a central bank is based more on its past actions than on institutional structures that afford it independence by insulating it from political concerns, although there is also a consensus that structurematters (Blinder 2000). Empirical research has found that institutional features related to central bank independence are associated with economic performance in cross sections of

Identification of Euro-Dollar Rate Dynamics Regimes: The Approach Based on Reconstructing Nonlinear Dynamic Systems

This paper proposes an empirical approach to euro-dollar rate modeling based on continuous-time dynamic systems. It is shown that the dynamics of the exchange rate and key policy rates of Federal Reserve System and European Central Bank (which are supposed to be the main drivers of the euro-dollar rate) has displayed several regimes in the past, and these regimes can be successfully modeled in terms of linear differential equations. The Grobman-Hartman theorem is used to reconstruct the fundamental nonlinear law of motion of the exchange rate. Linear systems are considered as approximations of a nonlinear system in the neighborhood of its steady states. This approach allows reveal all possible regimes of exchange rate dynamics.

The nexus between exchange rates and stock markets: evidence from the euro-dollar rate and composite European stock indices using rolling analysis

Both the goods market hypothesis and the portfolio balance theory, suggest a nexus between exchange rates and stock prices, albeit with a different direction of causality. This paper, using daily data, takes up the issue of the linkages between stock prices and exchange rates in the case of the euro-dollar rate and two composite European stock market indices: the FTSE Eurotop 300 and FTSE eTX All-Share Index. It addresses the causal ordering issue between the two markets using rolling unit root, cointegration and Granger causality tests. This methodological approach allows for the emergence of a clearer picture of the possible dynamic linkages between exchange rates and stock prices. The empirical results provide evidence of time-varying causality between the two markets.

Can We Explain the Sign-Switching Behavior of Cross-Country Interest Rate Correlations?

This paper considers the well established empirical fact that conditional correlations among cross-country interest rates switch signs. Switching implies an alternation of coupling and decoupling of global bond markets over time. This evidence is robust to alternative estimation schemes. Here we use a seminonparametric (SNP) model with a BEKK-GARCH variance function to estimate conditional second moments both to confirm these results and to provide auxiliary models for structural estimation of term structure models. Using an extensive historical analysis, we find that major driving forces behind the sign-switching behavior of conditional correlations between the Eurodollar rate and the Euroyen rate are synchronization and dis-synchronization of business cycles and coordination and discoordination of monetary policies triggered by international policies and financial market crashes. Especially, we find that the two interest rates are more likely to couple when both the U.S. and Japan slip into a recession while the likelihood of decoupling is highest when both economies are in expansion. We also explore whether proposed International Affine Term Structure Models (IATSMs) and International Quadratic Term Structure Models (IQTSMs) are able to reproduce the sign-switching behavior of conditional correlations among cross-country interest rates. We find that a small subset of the IATSMs can generate sign-switching behavior but only by forgoing their ability to describe other features such as the positivity of nominal interest rates, heteroskedasticity in volatility, and correlations among underlying state variables. In contrast, the IQTSMs are able to generate it without limiting their ability to describe other dynamic features. Using the MCMC-Efficient Method of Moments (EMM), we test the empirical performance of the models in reproducing the sign-switching behavior of conditional correlations. The result suggests that the IATSMs conclusively fail to capture it while the IQTSMs are relatively successful but fail to reproduce ephemeral ones.

Empirical Investigation of the Size and the Nature of the Eurodollar Futures-Forward Differential

We investigate the magnitude of the forward-futures differential, also known as the convexity adjustment, for Eurodollar interest rate instruments and attempt to identify factors affecting its size using an extensive sample for the 1988-2007 period. The innovative feature of our analysis is that the construction of the differential is extended from using rates for maturities up to twelve months as in previous published research to rates for maturities up to three years through the use of swap rates that allows us to build the extended term structure of spot and forward rates. Opposite to the previous findings, we find that the magnitude of the forward-futures differential is much smaller than what was reported in earlier studies, and that its sign is negative on many occasions which contradicts theoretical implications. We further check for potential data skews and other imperfections that may be behind the obtained results and find that neither asynchronicity bias, nor the unconventional feature of the Eurodollar futures pricing can explain the observed phenomena. The term structure interpolation error and the two business day lag between the fixing (settlement) date and the transaction (value) date the implied forward rates and prices are applied to cannot be attributed to the observed abnormality either. We also find that the level of interest rates is a significant positive factor behind the differential and its explanatory power is magnified if the regression analysis is conducted for the price differential instead of that for the rate differential which also results in a better goodness-of-fit.

From Default Correlation to Implied Hazard Rate Densities

In this paper I show that the standard deviation of a CDO implied hazard rate density increases with increased correlation between firms' default intensity processes. This is done by generating CDO tranches spreads from a model where firms' defaults are modelled by jump-diffusion hazard rate processes that are correlated through systematic jumps, correlation in the processes' random shocks, or both. The increase in the standard deviation of a CDO implied hazard rate density holds irrespective of how the jump-diffusion hazard rate processes' are correlated. In addition, model simulations indicate that systematic jumps that are rare and with large mean size are required to yield senior CDO tranche model spreads that are consistent with market quotes. This observations supports similar conclusions reported in the existing literature. Further to this, I propose a model where the default of one firm triggers the default of other firms. When the number of firms hit by this default is approximately 1/3 of a CDO's reference portfolio, I am able to produce model spreads that are within range of the extreme spreads observed during the 2007-2008 credit crisis. In addition, using a vector autoregression on daily observations, I provided evidence that lags of the standard deviation of the implied hazard rate density and the spread of the 3-month Eurodollar and 3-month T-Bill rates (TED spread) are factors for one-period ahead prediction of each other.

Eurodollar Exchange Rate Sensitivity of Dutch AEX Listed Firms

Eurodollar Exchange Rate Sensitivity of Dutch AEX Listed Firms

Is reversion to PPP in euro exchange rates non-linear?

The paper tests for nonlinearities in the adjustment of the euro exchange rate towards purchasing power parity (PPP). It presents new survey based evidence consistent with non-linear patterns in euro exchange rate dynamics. Moreover, based on an exponential smooth transition autoregressive (ESTAR-) model, it finds strong evidence that the speed of mean reversion in euro exchange rates increases non-linearly with the magnitude of the PPP deviation. Accordingly, while the euro real exchange rate can be well approximated by a random walk if PPP deviations are small, in periods of significant deviations, gravitational forces are set to take root and bring the exchange rate back towards its long-term trend. Deviations from the PPP equilibrium for the euro-dollar rate need to be stronger in order to reach the same adjustment intensity as for other rates.

The dynamic relationship between the federal funds rate and the Eurodollar rates under interest‐rate targeting

PurposePrevious literature for the relations between the market interest rates and the targeted or target rate of the Federal Reserve paid little attention to Eurodollar market rates. The present paper attempts to fill this void.Design/methodology/approachThe study investigates the dynamic relationship between the federal funds rate and three short‐term Eurodollar deposits rates. Cointegration analysis is utilized to examine the long‐run relationships between the short‐run dynamics of the market and targeted rates through a vector error‐correction mechanism.FindingsThe study shows strong evidence that, while the Eurodollar rates and the federal funds rate move together over time regardless of procedural differences in targeting, how they co‐move, especially how they adjust toward long‐run equilibrium, appears to be related to the targeting procedural changes.Research limitations/implicationsFurther research should be conducted for the theoretical analysis of strategic interactions between the monetary authority and market participants in the domestic and external financial markets.Practical implicationsThe result suggests that the Fed may affect the market interest rates through a policy of changing the federal funds rate target by a “fixed” amount for the foreseeable future. Such a policy has improved the market's ability to predict the size and timing of the changes in the target rate.Originality/valueThe results of the paper give some new insights into the interactions between monetary policy operations and market interest rates, which is of interest to researchers, monetary authorities, and financial market participants.