Integration of Key Worldwide Money Market Interest Rates and the Federal Funds Rate: An Empirical Investigation

Krishna M. Kasibhatla

The International Journal of Business and Finance Research, 2012, vol. 6, issue 4, 125-138

Abstract: This study investigates whether there is an increased integration of U.S. domestic money market interest rates and the Eurodollar market interest rates following two important changes that the U.S Federal Reserve (the Fed) implemented. First, elimination of reserve requirements on Eurodollar bank deposits in the early 1990s. Second, change in the operating procedure for conducting monetary policy in early 1992 from borrowed reserves targeting to federal funds rate targeting. The money market interest rates are three and six month Eurodollar London Interbank Offered Rates (Libor), three and six month U.S. Treasury bill (T-bill) rates, and the effective federal funds rate. Cointegration and error-correction methodology of Johansen and Juselius (1990,1992) is employed for this empirical study. Results indicate that integration of the five interest rates increased following the two changes by the Fed. It is the effective fed funds rate and the three-month T-bill rate that participate in the adjustment process back to their equilibrium path following an external shock to the system. Granger causality tests produced different and somewhat conflicting results when the error-correction model is estimated with and without the federal funds rate in the system. This finding requires further study and investigation.

Keywords: LIBOR; Unit Root; Cointegration; Granger Causality (search for similar items in EconPapers)
JEL-codes: C58 E43 G15 G32 (search for similar items in EconPapers)
Date: 2012
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