On the Nonlinear Specifications of Short-Term Interest Rate Behavior: Evidence from Euro-Currency Markets

Thomas Chiang () and Jeanette Jin Chiang

Review of Quantitative Finance and Accounting, 1999, vol. 12, issue 4, 70 pages

Abstract: This paper presents a coherent nonlinear interest rate model that incorporates the dynamics of the error correction specification into the traditional term structure model. The joint tests based on six Euro-Currency rates indicate that the linear specification should be rejected. The estimated equation suggests that the linear components--the change of the long-term interest rate and the error correcting term are highly significant. The nonlinear components involving the higher order of the independent variables, the cross products, the lagged error squares, and/or the ARCH effect also present significant explanatory power for predicting short-term Euro-Currency rate changes, confirming the non-linear specifications. Copyright 1999 by Kluwer Academic Publishers

Date: 1999
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