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Econ616 – Spring 2006

Econ616 – Spring 2006. The Spillover Effects of Deposit Rate between Japan and the United States: a Bivariate GARCH Model Yan Hu. Objective.

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Econ616 – Spring 2006

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  1. Econ616 – Spring 2006 The Spillover Effects of Deposit Rate between Japan and the United States: a Bivariate GARCH Model Yan Hu

  2. Objective • To employ the bivariate GARCH methodology to investigate the deposit rate transmission and its volatility spillover effects between the United States and Japan.

  3. Motivation • Japan and the United States have strong economies and different banking systems. • The deposit rate transmission and spillover effects are generally overlooked in the existing literature. • To examine the spillover effects of variables with time-varying conditional variances as well as covariance, academicians use the multivariate GARCH model.

  4. Literature Review (1) • International linkages of interest rate among financial markets --- Kirchgassner and Wolter(1987, 1993), Karfakis and Moschos (1990) and Fung and Lo (1995): examine international interest rate transmission primarily on conditional mean values, and find strong contemporaneous correlations and/or transmission of various interest rates.

  5. Literature Review (2) • Using Multivariate GARCH model to examine the spillover effects of variables with time-varying conditional variances as well as covariance: --- Bollerslev (1990): the conditional volatility is lower and the coherence among exchange rates is higher in the post-EMS period. --- Hu, Jiang and Tsoukalas (2004): the volatility of log returns of European currencies had generally decreased. • Volatility spillover of economic variables --- Ross (1989): information transmission speed is more relevant to the conditional variance of an asset’s price changes. --- Kearney and Patton (2000): German mark plays a leading role in the transmission of volatility.

  6. Multivariate Model • Y=βX Hij(t)=cij+AijHij(t-1)+Bijui(t)uj(t) • For bivariate, constant correlation: • BEK formulation (Engle and Kroner (1995)) directly imposes positive definiteness on the variance matrix: H(t)=C’C+B’u(t)u’(t)B+A’H(t-1)A

  7. Model

  8. DATA • International Financial Statistics (IFS): • monthly deposit rate • money market rate • long-term government bond yield • The sample period is from January, 1982 to June, 2003.

  9. Sample Description Japan United States No. of Observations 257 257 Mean -0.015222 -0.010345 Variance 0.033900 0.002972 Skewness -0.80832*** -0.88139*** Kurtosis 20.69253*** 2.38460*** Jarque-Bera 4613.08790*** 94.16577*** LM(χ2) 10.006345** 24.390088*** Q(8) 23.4962*** 7.7818 Q(16) 65.6287*** 13.0858 Q(24) 91.9187*** 16.7850

  10. Empirical Results R1,t = 0.0003 - 0.0316 R1,t-1 - 0.0634 R2,t - 0.0237 R2,t-1 + 0.1136 BY1,t (0.257) (-1.752)* (-2.775)*** (-1.106) (6.142)*** +0.0981 BY1,t-1 + 0.4310 MM1,t + 0.1596 MM1,t-1 (6.402)*** (40.640)*** (10.036)*** R2,t = 0.0006 - 0.1062 R2,t-1 -0.0049 R1,t + 0.0015 R1,t-1 + 0.4301 BY2,t (0.337) (-1.477) (-0.498) (0.166) (8.101)*** - 0.003 BY2,t-1 + 0.6149 MM2,t + 0.3199 MM2,t-1 (-0.049) (14.380)*** (4.660)*** H11 = 0.0013 - 0.0012 h11,t-1 + 4.1837 ε21,t-1 - 0.000124 VOL2,t-1 (3.85)*** (-1.16) (6.08)*** (-3.95)*** H22 = 0.0004 + 0.3849 h22,t-1 + 0.3118 ε22,t-1 - 0.000002 VOL1,t-1 (3.08)*** ( 2.58)*** (2.62)*** (-0.13)

  11. Hypothesis Test (1) • 1. The basic bivariate GARCH (1,1) model is appropriate: • The basic bivariate GARCH model is appropriate:H1: β11 = β12 = β13 = β14 = β15 = β16 = β17 = β21 = β22 = β23 = β24 = β25 = β26 = β27 = α11 = α12 = α13 = α21 = α22 = α23 = 0 • The variance is constant for Japan and the United States, respectively: • H2: α11 = α12 = α13 = 0 • H3: α21 = α22 = α23 = 0

  12. Hypothesis Test (2) • 2. Log difference of deposit rate is transmitted at the mean level: • There are no spillover effects in the mean level between Japan and the United States:H10: β12 = β13 = β22 = β23 = 0 • There is no spillover effect in the mean level from the United states to Japan:H11: β12 = β13 = 0 • There is no spillover effect in the mean level from Japan to the United States:H12: β22 = β23 = 0;

  13. Hypothesis Test (3) • 3. There are deposit rate volatility spillover effects: • There is no deposit rate volatility spillover between Japan and the United States:H13: α13 = α23 = 0 • There is no deposit rate volatility spillover from the United States to Japan:H14: α13 = 0 • There is no deposit rate volatility spillover from Japan to the United States:H15: α23 = 0 T-stat = -3.95*** T-stat = -0.13

  14. Conclusion • Bivariate GARCH (1,1) is appropriate for analyzing the deposit rate transmission and volatility spillover effects. • The deposit rate of one country is affected by domestic long-term government bond yield and money market rate. • Both at the mean level and the volatility level, the deposit rate transmission is from the United States to Japan.

  15. Future Research • Include more countries into the model: multivariate GARCH model. • Compare the deposit rate transmission with other interest rate transmission.

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