An Empirical Study On The Linkage Of Long-term Interest Rates Between China And The Developed Six Countries Before And After The Subprime Mortgage Crisis

The low and unresponsive US long term interest rates despite increasing short rates raised concerns about the possible failure of the monetary policy transmission mechanism in the US,see Greenspan(2005).This phenomenon was called Greenspan Conundrum.Yao Yu Dong and Li Hongjin(2011)mentioned that during the past decade,Chinese bond market has achievedfast development,the bond market interest rates have been basically liberalized,but the long term risk-free rates were too low and not sensitive to shortterm rates,which was called Chinese Greenspan Conundrum.Domestic scholars were concerned about the decoupling phenomenon of China’s long and short interest rates,explained the reasons for this phenomenon from the domestic perspective and supplied policy recommendations.However,the decoupling of short and long interest rates has been a distinctive feature since the 2000s.Since the interest rate conundrum has not been exclusive to US,but also a feature of other countries,it seems important to extend the analysis beyond one country.This paper will analyze the co-movements in long term interest rates between China and six major industrial countries(France,Sweden,Canada,the United States,New Zealand and the United Kingdom)before and after the Global FinancialCrisis,build a global common factor to explain the long-term interest rate changes in China and other industrial countries,verified the existence ofrisk Spillover Effect in Interest Rate Market.Finally,this paper explores the Granger causality relationship between the common factors S1tand S2t before and after the Global FinancialCrisis.We investigate whether international forces,such as global inflation,global output,or the global savings may be behind this global latent factor.The global factor may be linked to the observed break in the relationship between country-specific short and long term rates and to the much discussed failure in the transmission of monetary policy from 2008 in China.Since the 1990s,monetary policy has generally changed from quantitative to price regulation,and interest rate has become more and more important as the goal of monetary policy intermediary.The analysis of domestic and international interest rates co-movement is a vibrant area of academic research with vital policy consequences.Typically,a Central Bank relies upon the domestic correlation over the maturity spectrum of interest rates for the transmission mechanism of monetary policy.The domestic relation between interest rates and maturity is typically summarized by the yield curve.Basic theory,in the guise of the Expectations Hypothesis of the term structure,motivates this co-movement suggesting that long rates are influenced by current and expected short term rates.But there is little theoretical and empirical consensus on the domestic nexus between current short and long term interest rates.Short rates start moving upwards,while long rates are sluggish to respond and often even drop below the respective short rates.In this paper,we analyze the co-movement of short and long rates both domestically and internationally.After the Global FinancialCrisis,with the increasing degree of interdependence between countries,the co-movement between interest rates in the future will continue to increase,from the international and domestic perspective to explore the causes of this phenomenon will help in the future policy choices.At the same time,this paper will also disentangle the latent global factors behind the interest rates co-movements in order to discriminate among competing explanations for the low levels of the long rate observed at the international level before and after the Global FinancialCrisis.In the end,the paper provides an expectation about future term spread.Domestic scholars mainly analyze the causes of weak short-term interest rate linkagefrom the domestic perspective,such as improving the bond yields curve,enhancing the long-term bond market depth and liquidity recommendations,but there is almost no papers analyzing from an international perspective of long and short interest rate decoupling phenomenon in China.Our work is different from previous efforts in the area in at least 3 dimensions.First,we focus and compare the domestic and international long-term interest rate before and after the financial crisis,and explain the "upside down" phenomenon of China’s long and short interest rates during this period,disentangle the latent global factors behind the interest rates co-movements.Considering the decoupling phenomenon of long and short interest rates and the parameter estimation of high dimensional volatility modeling,this paper uses independent component analysis method(ICA)to extract one independent component of six major industrial countries as global common factor.Secondly,we use ICA-GARCH model to test the volatility spillover effect between the international long-term interest rate market and further explore the common factor’s explanation o before and after thecrisis.The empirical results show that there is a volatility spillover effect in the long-term interest rate market,and the global common factor can explain the long-term interest rate changes of the industrial countries.Especially after the outbreak of the financial crisis,the international long-term interest rate market co-movementsare significantly enhanced,the common factor can significantly explain long-term interest rate changes in China suggesting that after the financial crisis,Chinese long-term interest rates and international interest rate market are closely linked from the international perspective.Thirdly,this paper tests the Granger causality of the common factor and global savings,inflation and economic output in order to explore international potential causes that may affect long-term interest rate.Finally,we comprehensively analyze the factors that may influence the long-term interest rate movements in a country.The empirical results show that after the crisis,global savings and long-term interest rates are Granger reasons and interactions.At the same time,long-term interest rates are more influenced by monetary policy and are determined bylong-term economic fundamentals.The significant consistency between global savings and long-term interest rates is rooted in the fact that both them are heavily influenced by the fundamentals of a country’s economy.With rapid development of globalization,one country’s financial and monetary policy will consider other countries.It is not difficult to understand the relationship between the two trends.After the Global FinancialCrisis,on average,the common factor S2t extracted from this paper can explain 16.67%of the long-term interest rate changes in industrial countries.The explanations for the long-term interest rate change in China have increased significantly from 3%to 5.2%during this period,though also significantly lower than that of these industrial countries.Therefore,whileinvestigating the possible sources of the global factors,we also need to consider other factors affecting long-term interest rate co-movements.