Comovements in Volatility in the Euro Money Market

Abstract

This paper assesses the sources of volatility persistence in Euro Area money market interest rates and the existence of linkages relating volatility dynamics. The main findings of the study are as follows. Firstly, there is evidence of stationary long memory, of similar degree, in all series. Secondly, there is evidence of fractional cointegration relationships relating all series, except the overnight rate. The common long memory factor analysis points to a two-factor volatility curve. The most important factor, in terms of proportion of total variance explained, can be interpreted as a level factor (64% of total variance), while the other as a slope factor (13% of total variance). Impulse response analysis and forecast error variance decomposition finally point to forward transmission of shocks only, involving the closest maturities.

Keywords: Money market interest rates, liquidity effect, realized volatility, fractional integration and cointegration, fractional vector error correction model

JEL Classification: C32, F30, G10