Cross‐sectional Restrictions on the Spot and Forward Term Structures of Interest Rates and Panel Unit Root Tests

Ilias Lekkos

Journal of Business Finance & Accounting, 2003, vol. 30, issue 5‐6, 799-828

Abstract: In this paper we examine the stationarity of all the rates comprising the USD, GBP, DM and JPY spot and forward term structures. Instead of focussing on short maturity interest rates, as most other papers do, we perform a detailed analysis of the whole range of spot and forward interest rates of the 4 main currencies. We investigate the issue of stationarity within the framework of an equilibrium interest rate model such as Vasicek (1977), that defines the cross‐sectional and time series properties that interest rates of various maturities must satisfy. We show that within a one‐factor interest rate model, such as Vasicek, all interest rates are restricted to exhibit the same mean reverting behaviour. This restriction allows us to apply more powerful panel unit root tests. This methodology increases considerably the number of observations available and as a result the power of the unit root tests. The higher power of these tests allows us to demonstrate that there does exist mean reversion on the spot and forward US interest rates and the forward DM and GBP interest rates.

Date: 2003
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