The effects of a foreign interest rate on the domestic interest rate

This paper studies the Vasicek and Cox, Ingersoll and Ross models for the United States and the United Kingdom. For the approximation of the continuous interest rate, the 3-month Treasury Bill rate is used for the United States and the 10-year interest rate on government securities is used for the United Kingdom. Both countries are first considered separately, to estimate the parameters for the Vasicek and Cox, Ingersoll and Ross model. This way, the differences between both interest rates are highlighted. The estimation is done with themaximum likelihood method. After this, both countries are taken together in a multi-country model to look at the influences off an interest rate of a foreign country on the domestic interest rate. This parameter estimation is done with the generalized method of moments. In the parameter estimation, the main conclusion is that the effects of the United States on the United Kingdom are larger and more significant than the other way around. This paper uses the paper “Do we need multi-country models to explain exchange rate and interest rate and bond return dynamics”(2) by Robert Hodrick andMaria Vassalou for the fundament and the structure.