The EHTS and the persistence in the spread reconsidered. A fractional cointegration approach

Abstract

In this paper, we consider the possibility that a fractionally cointegrated vector autoregressive (FCVAR) model could serve as a novel empirical tool for examining the US term structure of interest rates. This econometric approach allows one to test the existence of a long-run relationship between short- and long-term interest rates and spread persistence together. As one of the main contributions of this paper, we elaborate on new scenarios of the degree of noncontemplative EHTS fulfillment. Monthly time series are constructed with nine different maturities of interest rates for the period of 1993 to 2018. The results obtained contribute new scenarios not previously presented in the literature. We also find that the persistence of spread is the stronger the larger the difference in maturity is between considered interest rates, revealing a long memory process. Importantly, as the main implication of our study, we find that this persistence implies a gradual loss of controlling power over interest rates by FED.