Interest rate pass-through: a nonlinear vector error-correction approach

Michal Ksawery Popiel

doi:10.1515/snde-2016-0063

Published by De Gruyter August 8, 2017

Interest rate pass-through: a nonlinear vector error-correction approach

Michal Ksawery Popiel

From the journal Studies in Nonlinear Dynamics & Econometrics

https://doi.org/10.1515/snde-2016-0063

Showing a limited preview of this publication:

Abstract

This paper analyzes pass-through from money market rates to consumer retail loan and deposit rates in Canada from 1983 to 2015 using a nonlinear vector error-correction model. This model permits estimation of long-run pass-through coefficients while simultaneously accounting for asymmetric adjustments and short-run dynamics. In contrast to empirical frameworks used in previous studies, it also allows testing of commonly made assumptions such as exogeneity of the market rate, making inference more robust. I find that pass-through was complete for all rates before the financial crisis although only after the mid 1990s for the 1 year mortgage rate. Since the end of the 2008–2009 recession, pass-through remains complete in the mortgage market but has significantly declined for deposit rates. Furthermore, many rates adjust asymmetrically but the direction of rigidity differs among rates and time periods.

Keywords: interest rate pass-through; cointegration; asymmetric adjustment; nonlinear vector error-correction model

A Appendix

Table 11:

Hypothesis test results for deposit rates.

			Conditional
Term	Time	H1,2δ	H1α,δ\|Hβ	H2α,δ\|Hβ	Hβ\|H2α,δ
FTD 3 months	’83-’96	11.24	14.62^***	0.14	3.61^*
	’96-’07	8.97	–	5.10^*	0.50
	’09-’15	137.14	7.68^**	0.69	3.64
GIC 1 year	’83-’96	3.89	98.26^***	0.00	0.28
	’96-’07	5.46	78.15^***	1.32	1.04
	’09-’15	20.69^**	–	3.07	14.22^**
GIC 3 years	’83-’96	61.65^***	109.19^***	–	–
	’96-’07	27.44^***	102.25^***	0.71	0.01
	’09-’15	1.79	3.79^*	2.08	17.83^***
GIC 5 years	’83-’96	16.56^***	37.55^***	2.37	2.34
	’96-’07	10.17^*	59.54^***	2.36	2.91
	’09-’15	44.08	5.62^**	0.38	16.81^***
FTD 5 years	’83-’96	16.24^***	24.41^***	1.59	23.35^***
	’96-’07	13.14^**	–	1.32	6.60^**
	’09-’15	21.34^*	–	1.85	37.34^**

This table reports the likelihood ratio test statistics for each of the hypotheses of interest in the following order: (1) H1,2δ tests for the presence of asymmetric adjustments in the error-correction; (2)–(3) Hiα,δ|Hβ for i ∈ {1, 2} tests for weak exogeneity of the market rate and retail rate, respectively, conditional on complete pass-through; and (4) Hβ|H2α,δ tests for complete pass-through conditional on weak exogeneity. Results are based on 4999 bootstrap samples. Statistical significance at the 10%, 5%, and 1% level is denoted by ^∗, ^∗∗, and ^∗∗∗, respectively. If the roots of the characteristic polynomial are inside the unit circle for a given hypothesis, the LR statistic is not reported.

Table 12:

Hypothesis test results for deposit rates before change in deposit insurance limit.

			Unconditional				Conditional		Joint
Rate	Time	H1,2δ	Hβ	H1α,δ	H2α,δ	H2α,δ,Γ	H¯2α,δ,Γ	H¯β	H2α,δ,Γ∩Hβ
FTD 3 months	’96-’04	5.64	2.81	23.43^***	2.59	2.69	1.48	1.60	4.29
GIC 1 year	’96-’04	6.25	0.07	60.91^***	0.14	0.22	0.25	0.11	0.33
GIC 3 years	’96-’04	26.30^***	0.42	–	1.87	2.01	2.11	0.52	2.53
GIC 5 years	’96-’04	13.13^**	0.94	68.55^***	5.90^*	7.85^*	7.13^*	0.23	8.08
FTD 5 years	’96-’04	16.43^**	2.02	67.36^***	4.72	6.05	5.49	1.47	7.51

This table reports the likelihood ratio test statistics for each of the hypotheses of interest in the following order: (1) H1,2δ tests for the presence of asymmetric adjustments in the error-correction; (2) Hβ tests for complete pass-through; (3)–(4) Hiα,δ for i ∈ {1, 2} tests for weak exogeneity of the market rate and retail rate, respectively; (5) H2α,δ,Γ tests for strong exogeneity of the market rate; (6) H¯2α,δ,Γ tests for strong exogeneity conditional on complete pass-through; (7) H¯β tests for complete pass-through conditional on strong exogeneity of the market rate; and (8) H2α,δ,Γ∩Hβ tests the joint hypothesis of complete pass-through and strong exogeneity of the market rate. Results are based on 4999 bootstrap samples. Statistical significance at the 10%, 5%, and 1% level is denoted by ^∗, ^∗∗, and ^∗∗∗, respectively. If the roots of the characteristic polynomial are inside the unit circle for a given hypothesis, the LR statistic is not reported.

Table 13:

Coefficient estimates for deposit rates before change in deposit insurance limit.

Rate	Time	β	ρ	α₁	δ₁	δ₂	ψ
FTD 3 months	’96-’04	−1.000	1.660	−0.055
GIC 1 year	’96-’04	−1.000	1.323	−0.174
GIC 3 years	’96-’04	−1.000	0.842	−0.613	0.543	0	824.678
GIC 5 years	’96-’04	−1.000	0.713	−0.316	0.243	0	5.728
FTD 5 years	’96-’04	−1.000	0.837	−0.343	0.271	0	7.916

This table reports the coefficient estimates from the final restricted models: β and ρ are the coefficients for pass-through and markup; α_i and δ_i are the linear and nonlinear adjustment coefficients, respectively – subscript 1 is for the retail rate and 2 is for the market rate – and ψ is the parameter determining the behaviour of the logistic function.

Table 14:

Hypothesis test results for mortgage rates.

			Conditional
Term	Time	H1,2δ	H1α,δ\|Hβ	H2α,δ\|Hβ	Hβ\|H2α,δ
MR 1 year	’83-’96	43.65^***	79.21^***	2.52	42.70^***
	’96-’07	9.82	13.74^***	0.01	0.03
	’00-’07	8.94^*	38.28^***	0.10	0.20
	’09-’15	5.09	7.82^**	2.54	0.03
MR 3 years	’83-’96	34.27^***	79.30^***	0.54	0.02
	’96-’07	4.79	17.69^***	0.01	2.71
	’01-’07	2.16	29.18^***	0.01	0.23
	’09-’15	35.94^***	56.28^***	0.88	4.13
MR 5 years	’83-’96	15.27^***	39.65^***	0.23	0.43
	’96-’07	6.03	6.37^*	0.82	0.77
	’00-’07	1.15	40.56^***	0.46	0.03
	’09-’15	61.71^***	–	0.19	17.59^**

This table reports the likelihood ratio test statistics for each of the hypotheses of interest in the following order: (1) H1,2δ tests for the presence of asymmetric adjustments in the error-correction; (2)–(3) Hiα,δ|Hβ for i ∈ {1, 2} tests for weak exogeneity of the market rate and retail rate, respectively, conditional on complete pass-through; and (4) Hβ|H2α,δ tests for complete pass-through conditional on weak exogeneity. Results are based on 4999 bootstrap samples. Statistical significance at the 10%, 5%, and 1% level is denoted by ^∗, ^∗∗, and ^∗∗∗, respectively. If the roots of the characteristic polynomial are inside the unit circle for a given hypothesis, the LR statistic is not reported.

Table 15:

Hypothesis test results for mortgage rates with swaps.

			Conditional
Term	Time	H1,2δ	H1α,δ\|Hβ	H2α,δ\|Hβ	Hβ\|H2α,δ
MR 1 year	’00-’07	5.78	35.90^***	0.58	3.21^*
	’09-’15	7.86	6.62^**	3.40^*	0.00
MR 3 years	’96-’07	5.87	12.72^***	0.24	0.65
	’00-’07	10.90^**	40.77^***	0.60	1.52
	’09-’15	15.05	18.90^***	1.12	0.07
MR 5 years	’96-’07	3.19	8.73^**	0.03	1.16
	’00-’07	0.75	56.21^***	0.02	0.00
	’09-’15	67.37^***	47.96^***	–	–

This table reports the likelihood ratio test statistics for each of the hypotheses of interest in the following order: (1) H1,2δ tests for the presence of asymmetric adjustments in the error-correction; (2)–(3) Hiα,δ|Hβ for i ∈ {1, 2} tests for weak exogeneity of the market rate and retail rate, respectively, conditional on complete pass-through; and (4) Hβ|H2α,δ tests for complete pass-through conditional on weak exogeneity. Results are based on 4999 bootstrap samples. Statistical significance at the 10%, 5%, and 1% level is denoted by ^∗, ^∗∗, and ^∗∗∗, respectively. If the roots of the characteristic polynomial are inside the unit circle for a given hypothesis, the LR statistic is not reported.

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Supplemental Material

The online version of this article offers supplementary material (DOI: https://doi.org/10.1515/snde-2016-0063).

Published Online: 2017-8-8

Interest rate pass-through: a nonlinear vector error-correction approach

Abstract

A Appendix

References

Supplemental Material

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