South Africa’s Short and Long Term Interest Rates: A Threshold Cointegration Analysis

Abstract

This paper presents a two-regime vector error-correction model (VECM) with a single cointegrating vector and a threshold effect in the error-correction term.  We use a Hansen-Seo (2002) algorithm to extract maximum likelihood estimates in eight threshold cointegration model s that  relate short-term to long-term interest rates in South Africa for the period 1990M1-2010M7. We employ a SupLM test to test for the presence of threshold. The Hansen-Seo algorithm yields both linear and non-linear estimates plus critical values used to test threshold effects. The method is applied by relating the South Africa Reserve Bank policy rate, the repo (short-term) to intermediate (TB rate, money market rate) and long-term rates (the 10-year government bond, the loan and deposit rates). In all cases, linear cointegration is rejected in favor of a threshold effect.