The Term Structure of Interest Rates as a Cointegrated System: Empirical Evidence from the Eurocurrency Market

In this paper the author examines the term structure of Eurocurrency interest rates from six countries (with maturities of one, two, three, and six months) using unit root tests and cointegration tests that are robust to departures from independent and identically distributed errors. The main conclusions are: (1) Eurocurrency interest rates have one (and only one) unit root when viewed individually, and (2) for each of the countries examined, Eurocurrency interest rates are cointegrated--with one equilibrium relationship--when viewed jointly. These conclusions are consistent with the weak form of the efficient market hypothesis and suggest that in efficient markets arbitrage generally prevents rates on different maturities of a given asset from drifting too far for an extended period.