The Role of Eonia in the Dynamics of Short-Term Interbank Rates

Abstract

To signal monetary policies and market expectations, we apply a fractionally cointegrated vector autoregressive (FCVAR) model, aiming to ana- lyse the expectations hypothesis of term structure (EHTS), persistence in the Euro Over Night Index Average (Eonia) spread and permanent-transitory decom- position using a novel approach. We use a monthly frequency sample for the 3- month Euribor rate and Eonia rate, covering the period from January 1999 to February 2019. The results obtained confirm the EHTS and show evidence of a high persistence of the spread, which means that shocks may impede effective- ness in monetary policy and that the European Central Bank (ECB) loses control over interest rates. Additionally, according to permanent-transitory decomposi- tion, we determine that the Eonia rate has a permanent component and thus dominates the common trend in the cointegration system. In sum, if the ECB wants to keep the interbank market interest rates under control, it must contem- plate the evolution of the Eonia rate.