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

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

models 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 a 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.