Relationship between expected treasury bill and Eurodollar interest rates: A fractional cointegration analysis

In this paper, we extend Booth and Tse's (BT) 1995 analysis of fractional cointegration between the expected Eurodollar and Treasury bill interest rates implied by their respective futures contracts. The definition of fractional cointegration suggested by Cheung and Lai (1993) and used by BT is refined so that it requires the cointegrating relationship to be stationary as well as mean-reverting. In addition to the Geweke and Porter-Hudak method used by BT, a more efficient Maximum Likelihood (ML) method is used to estimate the cointegrating relationship. The LM (Engle (1982)) test indicates the possible existence of a heteroscedastic cointegrating relationship. Therefore, we use heteroscedastic models (GARCH and Exponential GARCH) to represent the cointegrating regression instead of the simple homoscedastic model used by BT. The empirical evidence cannot reject the null hypothesis of a stationary fractional cointegration relationship between the Eurodollar and Treasury bill interest rates. © 2001 Kluwer Academic Publishers.