Uncovered Interest Rate Parity and the Expectations Hypothesis of the Term Structure: Empirical Results for the U.S. and Europe

Abstract

A system of U.S. and euro-area short and long-term interest rates is analyzed. According to the expectations hypothesis of the term structure, the interest rate spreads should be stationary and according to the uncovered interest rate parity, the difference between the U.S. and euro-area long-term interest rates should also be stationary. If all four interest rates are integrated of order one, one would expect to find three linearly independent cointegration relations in the system of four interest rate series. Combining German and European Monetary Union data to obtain the euro-area interest rate series, we indeed find the theoretically expected three cointegration relations, in contrast to previous studies based on different data sets.