Modeling International Long‐Term Interest Rates

Abstract

This study investigates the relationship among interest rates on the long‐term government bonds of five industrialized countries. Both standard and new unit root tests are applied, all of which confirm the presence of exactly one unit root. New cointegration tests are also applied to these data. In contrast to previous research on short‐term bonds, stock prices, and exchange rates, these results find little evidence of cointegration among the five long‐term interest rate series. Thus, when modeling or forecasting these central government long‐term bond yields, one may assume separate sets of fundamentals and difference the data to achieve stationarity. An error correction model may not be appropriate.

International bond market linkages: a structural VAR analysis

“…This is most obvious in the "R-representation", though we see a few very short peaks going beyond the line at 1.0 over the sample period in the "Z-representation". In sum, the result of recursive cointegration analysis confirms the finding of no cointegration, which is consistent with DeGennaro et al (1994) and Clare et al (1995), but contradicts Barassi et al (2001) and Smith (2002). As pointed out by Clare et al (1995), lack of the long-run relationship may be due to existence of remaining barriers to market access in international bond markets, such as heterogeneous taxation and maturity structure, investment culture, and institutional arrangements.…”

“…Recursive cointegration analysis clearly shows that no long-run relationship exists among the five bond markets during the sample period. The finding supports DeGennaro et al (1994) and Clare et al (1995), but contradicts more recent studies of Barassi et al (2001) and Smith (2002). Also, as found in Kirchgassner and Wolters (1987), there exist strong correlations between bond yield innovations.…”

“…Applying a cointegration technique, DeGennaro et al (1994) and Clare et al (1995) did not find any long-run cointegration relationship among government bond markets of several major industrialized countries. By contrast, Barassi et al (2001) and Smith (2002) reported existence of cointegration in these markets.…”

“…are as follows: the United States (US), Japan (JP), Germany (GM), the United Kingdom (UK) and Canada (CA). Most previous studies (e.g., DeGennaro et al, 1994;Clare et al, 1995;Sutton, 2000;Smith, 2002) also used monthly observations and focused on these five countries because of their importance in international bond markets. 4 Similar to Clare et al (1995) and Smith (2002), we use J.P. Morgan total return government bond indexes as proxies of (realized) government bond yields in this study.…”

“…The extent and the nature of linkages in international bond markets carry important implications for an independent monetary policymaking (e.g., Kirchgassner and Wolters, 1987;Sutton, 2000), modeling and forecasting long-term interest rates (e.g., DeGennaro et al, 1994), and bond portfolio diversification (e.g., Clare et al, 1995).…”