Exploring the Nexus Between Short- and Long-Run Rate of Interests in Turkey’s Bond Market

Abstract

This research analyzes the correlation between long- and short-term rate of interests in Turkey's government bond market, assessing the evidence in support of the Market Segmentation Theory (MST) and Expectations Hypothesis (EH). The research implements linear and nonlinear autoregressive distributed lag (ARDL and NARDL, respectively) approaches to address linearity, asymmetric effects, and structural breaks. The results indicate that short-term rate of interests have a substantial impact on mid-term (two-year and five-year) bond rates, backing the EH, while long-term (ten-year) rates conform to the MST and suggest the presence of segmented markets. Inflation, as measured by the Consumer Price Index, demonstrates a pronounced Fisher effect across various maturities, characterized by asymmetric responses to both positive and negative shocks. The error correction terms indicate that mid-term rates exhibit rapid adjustment, whereas long-term rates adjust more slowly. The findings of the Granger causality test provide further confirmation of the dynamic interactions by showing that changes in short-term interest rates and inflation have predictive power over the long-term rate of interests.

JEL Codes: E40, E43, B22, C32
Keywords: Rate of interest; Term structure; Government bonds; Expectations Theory; Market Segmentation Theory