Domestic‐Foreign Interest Rate Differentials: Near Unit Roots and Symmetric Threshold Models

Abstract

This paper investigates the near unit root behavior of interest rate differentials across countries using a symmetric Band‐TAR model that allows for a heteroscedastic error process. We find that the time series properties of monthly short‐term interest differentials over the period 1974–2005 between the United States and Canada, France, Germany, Japan, and the United Kingdom can be characterized by a symmetric Band‐TAR process, which can explain its (near) unit root behavior reported in the extant literature. Results significantly reject a linear model in favor of the alternative hypothesis of a two‐regime symmetric threshold model that exhibits significantly greater persistence within the threshold bands than when outside the threshold bands.