Journal of Financial Services Research 16:1 5±26 (1999)
# 1999 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
Interest Rate Asymmetries in Long-Term Loan and
Deposit Markets
BARRY SCHOLNICK
Faculty of Business, University of Alberta, Edmonton, Canada
Abstract
Studies of U.S. loan and deposit markets have found that consumer interest rates respond asymmetrically to
changes in market rates. If this ®nding is repeated across many different consumer ®nance product markets, then
it could have important implications for the transmission mechanism of monetary policy. This paper tests for
signi®cant interest rate asymmetries in consumer ®nance markets that differ markedly from those examined in the
existing literature. The main result of this paper is to reject the hypothesis of signi®cant asymmetries in most (but
not all) of the longer-term loan and deposit markets examined in Canada and the United States. This indicates that
the explanations for asymmetries given in the literature are not generalizable across different product markets in
different countries.
Key words: interest rates, asymmetries, consumer ®nance
1. Introduction
An important question in macro economics is the micro-economic issue of whether prices
are asymmetrically stickyÐwhether the speed at which a price rises is different from the
speed at which it falls. One particular set of prices that has elicited signi®cant attention in
this context are consumer interest rates set by banks. Consumer interest rates are a
particularly important set of prices in the macro-economic context because of their
potentially large role in the monetary policy transmission mechanism (Moore, Porter, and
Small, 1990; Heffernan, 1997). Recent papers including Hannan and Berger (1991),
Ausubel (1991), Neumark and Sharpe (1992), Hannan (1994), Calem and Mester (1995),
and Hutchison (1995) have documented that consumer interest rate asymmetries indeed
are signi®cant for a variety of short-term consumer ®nancial products in the United States,
including money market deposit accounts and credit card loans.
This paper examines whether signi®cant interest rate asymmetries exist in markets quite
different from the short-term U.S. markets examined in the literature. There are two main
reasons for undertaking this research. First, because of the possible role of consumer
interest rates in the monetary policy transmission mechanism, if the interest rate
asymmetries in the short-term U.S. markets are found to be widespread in different types
of consumer ®nance product market, then such asymmetries could have important
implications for monetary policy makers. Second, by examining the prevalence (whether
or not rates are signi®cantly sticky) and nature (sticky upward or sticky downward) of
6
BARRY SCHOLNICK
asymmetries in different product markets, it is possible to provide new evidence that may
or may not be consistent with the different theories explaining interest rate asymmetries
proposed in the literature.
A wide variety of theoretical explanations have been proposed to explain the observed
asymmetries in the U.S. markets. One set of theories relates to issues of market
concentration (Hannan and Berger, 1991; Neumark and Sharpe, 1992), another set to
issues of consumer behavior (Hannan and Berger, 1991; Rosen, 1995), and a third set to
issues of asymmetric information and adverse selection (Stiglitz and Weiss, 1981;
Ausubel, 1991; Calem and Mester, 1995). The market concentration and consumer
behavior explanations can apply to both loan and deposit markets, while the adverse
selection theories apply only to loan markets. Despite the many explanations for
asymmetries, less progress has been made on providing evidence to distinguish between
the different theories. Hannan's (1994) conclusion about the various theories is that they
all are ``speculative'' and that ``the observed asymmetry in the stickiness of deposit
rates . . . seem to represent a ®nding in search of a theory'' ( p. 265).
This paper uses the asymmetric error correction mechanism procedure to determine
whether longer-term consumer interest rates set by banks are either sticky upward, sticky
downward, or not signi®cantly asymmetric. The data set examined here includes longerterm loan and deposit interest rates in Canada; in particular, mortgage loan rates, car loan
rates, long-term ®xed-interest deposit rates, and savings deposit rates. For comparison, the
paper also examines data from the long-term U.S. mortgage market. These particular
products are different in a number of important respects from the short-term U.S. products
examined in the literature. The differences are important for evaluating the extent to which
the different theoretical explanations can be generalized across different types of
consumer ®nancial products in different national markets.
The ®rst important point concerning the products examined here is the extent of
concentration in the Canadian banking system relative to the United States. The Canadian
banking system is highly concentrated, with only six major banks dominating the market
across the whole country. The issue of concentration is one of the main explanations
provided in the literature for the existence of interest rate asymmetries. Hannan and Berger
(1991) and Neumark and Sharpe (1992) ®nd evidence from the U.S. market of a positive
relationship between concentration and asymmetric rigidity, which they ascribe to market
power held by banks in concentrated markets. If these conclusions were applicable in the
case of interest rates set by the big six Canadian banks, then these rates should display
signi®cant interest rate rigidity in the bank's favor. However, considerable debate in the
literature concerns whether concentration in a market indeed does imply that ®rms in the
industry possess and utilize market power (see Shaffer, 1994, for a complete review).
Therefore, an examination of the interest rates set by the big six banks in Canada provides
a mechanism for testing the U.S. ®ndings of Hannan and Berger (1991) and Neumark and
Sharpe (1992) that high concentration leads to signi®cant interest rate asymmetries.
The second difference between the type of consumer ®nancial products examined here
and those examined in the literature is that most of the products examined here, such as
home mortgages, car loans and long-term, ®xed-interest consumer deposits (guaranteed
investment certi®cates, or GICs) typically are markets involving greater monetary
quantities and longer time horizons. Consumer behavior with regard to longer-term bank
INTEREST RATE ASYMMETRIES
7
products such as mortgages could be quite different than consumer behavior with respect
to shorter-term products such as short-term deposit accounts or credit card loans. Many of
the theories proposed in the literature to explain asymmetric interest rate adjustment are
based on issues surrounding consumer behavior, including the issue of consumer
sophistication, search costs, and switching costs. These arguments essentially state that
banks have some degree of market power because of the way consumers choose consumer
®nancial products. By empirically examining the prevalence and nature of asymmetries in
longer-term market, it is possible to determine the extent to which these theories may be
applicable in longer-term product markets.
The main ®nding of this paper is that no signi®cant asymmetries can be detected in most
longer-term consumer interest rates in Canada or in long-term mortgage rates in the United
States. For those products where no signi®cant asymmetries can be detected, it is possible
to argue that the different explanations provided in the literature to explain the ®ndings of
asymmetries in the shorter-term U.S. product markets are not consistent with the data
presented here.
The paper is organized as follows. The next section provides a brief survey of the
different theoretical explanations of asymmetric interest rate adjustment, the third section
describes the asymmetric error correction methodology used, the fourth section gives the
results, and the ®fth provides the discussion.
2. Theories of interest rate asymmetries
Three main types of explanation for commercial bank interest rate asymmetries have been
proposed in the literature, based on concentration, consumer behavior, and issues of
adverse selection in markets for loans (but not deposits). These three explanations are
brie¯y discussed in turn.
2.1. Market concentration
The empirical link between asymmetric interest rate adjustment and market concentration
has been well documented in the context of deposit rates in the United States. The U.S.
banking system provides a rich source of data on different geographical markets that are
more or less concentrated. Neumark and Sharpe (1992) ®nd that ``banks in more
concentrated markets are slower to adjust deposit rates upward'' but were ``faster to adjust
interest rates downward'' ( p. 676). They conclude that, ``when market interest rates
¯uctuate in either direction, the adjustment behavior of banks in concentrated markets
seems to allow them to extract more surplus from depositors than banks in less
concentrated markets'' ( p. 676). Hannan and Berger (1991) reach a similar conclusion,
``that ®rms in more concentrated markets . . . exhibit greater price rigidity, all else equal,
and that deposit rates are signi®cantly more rigid when the stimulus for a deposit rate
change is upward'' ( p. 944).
Both papers have examined the market for deposits where ®rms with market power
ensure that deposit rates are sticky upward when the cost of funds increases. A similar
8
BARRY SCHOLNICK
argument can be made in the case of ®rms having market power in the loan marketÐonly
in this case a ®rm with market power would ensure that loan rates were sticky downward
when the cost of funds declined.
The issue of concentration as an indicator of market power in the banking industry,
however, is controversial, with a very large literature questioning whether concentration in
fact does give ®rms market power. Shaffer (1994), in a review of the literature on banking
and concentration, notes that ``the link between concentration and market power is not
uniform . . . competitive outcomes might be observed in concentrated markets as well as
unconcentrated ones, while . . . monopoly power might be sustained in unconcentrated
markets as well as concentrated ones'' ( p. 4).
The situation in the banking industry in Canada is very interesting in this regard. The
banking industry is considered to be concentrated in that it is dominated by the ``bigsix'' banks, which compete across the entire country. According to data from the
Canadian Mortgage and Housing Corporation, the top ®ve Canadian banks have a
market share of 62.5% of all mortgages issued in Canada (Beauchesne, 1998), and
according to the Royal Bank of Canada, the big six banks have a market share of 60% of
individuals, deposits in Canada and 73% of total deposits (Royal Bank Financial Group,
1996).
Using aggregate industry data (rather than the product level data used here) Shaffer
(1993) provides evidence on the extent of competition in the Canadian banking industry.
He concludes that ``the industry has resembled perfect competition,'' even though the
Canadian banking system is ``signi®cantly more concentrated than the United States''
( p.49). A ®nding in this paper of no signi®cant asymmetries in any individual product
market or the existence of asymmetries in favor of consumers would imply that the banks
were unable to ``extract more surplus'' (Neumark and Sharpe 1992, p. 767) through
asymmetric adjustment in that product market. Therefore, in as far as asymmetric
adjustment in the banks favor is an indicator of market power, a ®nding of no signi®cant
asymmetry at the product level would be consistent with Shaffer's (1993) aggregate level
conclusion, that the Canadian banking industry resembles a competetive market. On the
other hand, a ®nding of signi®cant asymmetries in the banks' favor would be consistent
with the conclusions of Hannan and Berger (1991) and Neumark and Sharpe (1992)
regarding the signi®cant relationship between concentration and asymmetric rigidities in
the banks' favor found in the shorter-term U.S. market.
2.2. Consumer characteristics
A wide variety of explanations for asymmetric interest rate rigidity have been given in the
literature based on the characteristics of consumers. Essentially, all these explanations
provide reasons for why a bank may have market power to asymmetrically alter its
prices to its own advantage. Potential causes of this market power include the level of
consumer sophistication, potential search costs, and potential switching costs faced by
consumers.
Most of these models have been invoked in the context of short-term consumer-type
products in the United States, such as money market deposit accounts (MMDA) and credit
INTEREST RATE ASYMMETRIES
9
card accounts. However, it remains an important question as to whether these explanations
are applicable to longer-term-type products, such as mortgages and long-term, ®xedinterest deposits (GICs).
One explanation for interest rate asymmetries in deposit markets (which also can be
applied to loan markets) given by Rosen (1995) is that some consumers are
``sophisticated'' and some are ``unsophisticated.'' In his model, Rosen (1995) argues
that sophisticated consumers are aware of all market interest rates, while unsophisticated
consumers are assumed to know only the current and previous interest rates of their own
bank. In essence, the greater the proportion of unsophisticated consumers in the market,
the greater is the ability of banks to asymmetrically adjust their interest rates to their own
advantage, giving the banks some degree of market power.
It is an empirical question as to whether the unsophisticated consumer argument can be
applied across different product markets. There could be a greater probability that a
consumer will act in an ``unsophisticated'' manner for smaller, short-term deposits and
loans than to longer-term deposits and loans, which often involve greater sums of money.
Also, a consumer who is ``unsophisticated'' in the market for short-term money market
deposits and credit card loans may be ``sophisticated'' in the market for mortgages and
long-term deposits. A ®nding that interest rates are not signi®cantly asymmetric in the
banks favor will be inconsistent with the argument that banks adjust their rates
asymmetrically because of unsophisticated consumers in that particular market.
The degree of sophistication of consumers is related to the issues of search costs and
switching costs, both of which have been invoked to explain interest rate asymmetries in
the market for credit card debt in the United States. The search cost argument (e.g., Calem
and Mester, 1995) states that consumers have large costs in searching for more
advantageous interest rates and so do not search for alternative suppliers of ®nancial
products, giving the banks some degree of market power. Switching costs occur when a
borrower faces costs in switching from one bank to another. If switch costs give banks
market power, then the banks may be able to asymmetrically adjust interest rates in their
own favor.
As in the unsophisticated consumers hypothesis, it is an empirical question as to
whether the issues of search and switching costs are relevant across the whole spectrum of
different consumer interest rates or apply only in markets for shorter-term ®nancial
products. The issue here essentially is one of the opportunity cost of not ``shopping'' for a
better deal. It would be expected that the smaller the opportunity cost of not shopping, the
greater is the market power of banks and thus an increasing tendency toward rates being
asymmetric in the banks favor. The opportunity cost of not shopping is a function of both
the maturity and size of a ®nancial product.
It is interesting to note that all the unsophisticated borrower, searching cost, and
switching cost explanations are based on the premise that banks have market power to
asymmetrically adjust rates in their own favor (loan rates sticky downward, deposit rates
sticky upward). However, an argument has been made by Hannan and Berger (1991) that
rates could be asymmetrically adjusted in favor of the consumerÐwhat they term the
negative customer reaction hypothesis. This argument states that, in a competitive market,
it may be in the banks interest to adjust rates asymmetrically in the consumers favor (loan
rates sticky upward, deposit rates sticky downward) to maintain consumers. They argue
10
BARRY SCHOLNICK
that consumers valued by a bank may move to alternative providers of ®nancial services if
they perceive that their bank is not asymmetrically adjusting interest rates in their favor.
Whether this hypothesis is relevant is an empirical matter and can be evaluated by
determining the direction (sticky upward or downward) of any signi®cant asymmetry.
2.3. Asymmetric information
While the market concentration and consumer behavior arguments can apply to both loan
rate as well as deposit rate asymmetries, the asymmetric information argument for
asymmetric interest rate adjustment applies only to bank loans and not to bank deposits.
Perhaps the most well-known theory linking asymmetric information and interest rates
is that of Stiglitz and Weiss (1981). This hypothesis concludes that loan rates should be
sticky upward. This is in contrast to most of the concentration and consumer behavior
explanations just given that loan rates should be sticky downward. While much of the
focus on the Stiglitz and Weiss argument has revolved around their prediction of credit
rationing (i.e., the quantity of loans), it also is possible to test their model by examining
whether interest rates are sticky (i.e., the price of loans). Berger and Udell (1992) argue
that a ``key testable implication of credit rationing is that the commercial loan rate is
`sticky', that is that it does not fully respond to changes in open market rates'' (p. 1048).
The Stiglitz and Weiss (1981) argument is that borrowers with a higher risk preference
will be attracted when banks raise their lending rates. Only borrowers whose projects have
a higher expected return, and thus a higher degree of risk, will demand funds at higher
rates. The result is that banks will be reluctant to raise lending rates, even if market rates
rise. The expected cost to the banks of not raising their own rates when the marginal cost of
funds increases will be offset by the bene®t from not encouraging higher risk borrowers to
borrow. The model predicts that lending rates should be signi®cantly more sticky upward
than downward. When market rates are falling, banks in this model do not face the adverse
selection problem described by Stiglitz and Weiss. Ausubel (1991) notes that ``StiglitzWeiss predict that interest rates are `upward-sticky' when costs rise and if anything interest
rates are `downward-quick' '' ( p. 71).
3. Methodology
The previous section listed a wide variety of theoretical explanations for asymmetric
interest rate adjustment, including market concentration, degree of consumer sophistication, searching costs, switching costs, negative customer reactions, and adverse selection.
There are differences among these theories in terms of the direction of the asymmetries
that they predict, for example, the concentration and consumer behavior hypotheses
predict that loan rates will be sticky downward, while the adverse selection and negative
customer reaction hypotheses predict that loan rates will be sticky upward. The empirical
aim in this paper is to test whether consumer interest rates in a variety of both loan and
deposit products are either sticky upward, sticky downward, or not signi®cantly
asymmetric. A ®nding of no signi®cant asymmetry in a particular product market implies
INTEREST RATE ASYMMETRIES
11
that the various explanations of asymmetric adjustment are not consistent with the data in
that particular market and thus that the possible impact of asymmetries on the transmission
mechanism of monetary policy will be reduced.
This paper utilizes time series techniques to evaluate whether signi®cant asymmetries
exist in different consumer interest rates. The use of the time series relationship between
wholesale and retail interest rates to examine the asymmetric adjustment of commercial
bank interest rates follows many other authors who examine these issues (Moore et al.,
1990; Hannan and Berger, 1991; Neumark and Sharpe, 1992; Rosen, 1995, Hutchison,
1995; Mester and Saunders, 1995, Scholnick, 1996). All these authors utilize an important
advantage in conducting research on the market for ®nancial products, which is that time
series data on the most important variable cost to banks, the costs of funds, is readily
available. It thus is possible to examine how prices (retail rates set by banks) respond to
changes in their main variable cost (wholesale rates set in the money markets).
The time series methodology used here is the cointegration and error correction
approach. The use of cointegration to examine the time series relationship between
different interest rates has become common in the term structure literature that examines
the relationship between market-determined interest rates of different maturities (e.g.,
Campbell and Shiller, 1987; Engsted and Tanggaard, 1994; Hall, Anderson, and Granger,
1992; and many others). This paper follows Diebold and Sharpe (1990), Moore et al.,
(1990), Scholnick (1996), and Heffernan (1997) in using cointegration and error
correction mechanisms to examine wholesale and retail interest rates.
The cointegration framework is an appropriate methodology to use if it is concluded that
the wholesale and retail interest rate series are not stationary. Standard OLS regression on
nonstationary parameters would not allow for inference (hypothesis tests) on the estimated
parameters, but the cointegration procedure allows for such testing. If cointegration is
found between the two nonstationary series, then this implies that wholesale and retail
interest rates form a long-run stationary equilibrium. This means that disequilibria
between the series will occur in the short run following an exogenous shock but that, in the
long run, the relationship between the series will return to an equilibrium. If it is concluded
that a long-run cointegrating vector exists between two nonstationary series then the Engle
and Granger (1987) representation theorem states that a short-run error correction
mechanism must exist. The error correction mechanism is used to model the short-run
disequilibrium dynamics of the cointegrating relationship. The coef®cient on the error
correction term is indicative of the rate at which the retail rate moves back to the long run
equilibrium position over time. Moore et al. (1990), Scholnick (1996), and Heffernan
(1997) all emphasize the estimation of the error correction coef®cient in terms of
examining the short-run dynamics of retail interest rates in response to changes in
wholesale rates.
Once a standard error correction model has been estimated, it is possible to test for
asymmetries of the endogenous retail rate in response to exogenous shocks to the
wholesale rate. The main disequilibrium dynamics of interest in this paper are whether
retail rate adjustment is signi®cantly asymmetric. To examine whether retail rates adjust
asymmetrically this paper utilizes the asymmetric error correction mechanism introduced
by Granger and Lee (1989) and used, for example, by Moore et al. (1992), Lee and Koray
(1994), and Scholnick (1996). A full description of nonlinear cointegration and error
12
BARRY SCHOLNICK
correction models is given in Granger and Terasvirta (1993). The Granger and Lee (1989)
procedure essentially is a dummy variable technique that allows for a test of whether the
speed of adjustment of the dependent variable (retail rate) varies under different conditions
that may be of interest.
In the literature on asymmetric adjustment of bank interest rates, two different types of
asymmetries have been evaluated. The ®rst type of asymmetry, used by Hannan and
Berger (1991), tests for whether the speed at which the retail rate responds is different
when the wholesale rate is increasing compared to when it is decreasing. The second type
of asymmetry, examined by Newmark and Sharpe (1992), Moore et al. (1990), and
Scholnick (1996), examines whether asymmetries exist if the retail rate is above or below a
long-run ``equilibrium'' value relative to the wholesale rate. This tests whether retail rates
respond differently when they are ``too high'' (i.e., above their long-run equilibrium level
with respect to the wholesale rate) than when they are ``too low'' (i.e., below their longrun equilibrium level with respect to the wholesale rate).
This paper follows Rosen (1995) in empirically examining both the wholesale rate
increasing/decreasing asymmetry as well as the retail rate too high/too low asymmetry.
The two types of asymmetries to some extent are similar, in that in both cases the
asymmetry can be in favor of either the bank or the consumer. Therefore, evidence from
either type of asymmetry can be considered evidence in favor of the different theoretical
explanationsÐconcentration, consumer characteristics, or asymmetric informationÐ
discussed previously. However, the two types of asymmetries clearly are different, and one
type can exist in the same data where the other is not evident. It is possible, for example,
for the wholesale rate to increase (which could result in a rise in the endogenous retail rate)
while the retail rate remains above its long-run equilibrium relationship relative to the
wholesale rate (which could be corrected by a fall in the retail rate). For this reason, both
types of asymmetry are examined empirically here.
In short, the cointegration/error correction mechanism methodology used here has three
important advantages in terms of modeling the relationship between wholesale and retail
interest rates. First, this methodology is designed to deal with nonstationary time series
data such as nominal interest rates; second, the methodology allows for the estimation of a
coef®cient that indicates the short-run dynamics of retail rates following changes in
wholesale rates; and third, it is possible to examine different types of asymmetries within
the error correction model.
The following discussion provides some of the formal econometric details related to the
cointegration/error correction methodology used here. The Johansen (1991) cointegration
methodology has become standard in the cointegration literature. The Johansen (1991)
procedure begins with a simple VAR model of order k:
X t ˆ m ‡ Pi Xtÿ1 ‡ ‡ Pk Xtÿk ‡ ei
…1†
where X t is a p-dimensional vector of I(1) or nonstationary variables, m is a constant term,
Pi . . . Pk are p6p-dimensional matrices of parameters, and the error term et is a vector of
independent and identically distributed Gaussian variables.
This model can be rewritten in the following format
DXt ˆ m ‡ Gl DXtÿ1 ‡ ‡ Gkÿ1 DXtÿk‡1 ‡ PXtÿk ‡ e
…2†
13
INTEREST RATE ASYMMETRIES
where
Gi ˆ ÿ…I ÿ P1 ÿ Pi †;
i ˆ 1; . . . ; k ÿ 1
…3†
P ˆ ÿ…I ÿ ÿ Pk †
Johansen shows that the reduced rank of P will determine the number of cointegrating
vectors in the system, r. Johansen proposed two different likelihood ratio tests to
determine the value of r: the maximal eigenvalue test and the trace test.
The matrix P can be factorized so that
P ˆ ab0
…4†
where both a and b are p6p matrices. The b matrix is the matrix of cointegrating vectors,
and the a matrix can be interpreted as the factor loadings parameters associated with the
cointegrating vectors. The Johansen procedures provides estimates of a and b and allows
inference testing on a and b.
In the term structure literature using cointegration models (e.g., Hall et al., 1992;
Engsted and Tanggaard, 1994), it is argued that the number of cointegrating vectors r in a
system of n different nonstationary interest rate series should equal n ÿ 1. Having n ÿ 1
cointegrating vectors implies that one nonstationary common trend ``drives'' (Hall et al.,
1992) the system of interest rates. If there are n cointegrating vectors (i.e., P is of full
rank), then the system as a whole would be stationary. The data used here examine
wholesale and retail interest rates of the same maturity rather than term structure data, but
it also can be expected that, in such a system of n nonstationary interest rates, there should
be less than n cointegrating vectors or else the system as a whole would be stationary. The
cointegration equations used in this paper only have n ˆ 2 (wholesale and retail rates);
therefore, this paper tests the hypotheses of r ˆ 0, r ˆ 1, and r ˆ 2. If r ˆ 0, then no
cointegrating vector exists; if r ˆ 2, then the system as a whole is stationary; but if r ˆ 1
then cointegration in the nonstationary system cannot be rejected.
It is possible to utilize the Johansen methodology to test for weak exogeneity within the
context of wholesale and retail interest rate systems (see Ericsson, 1992 and Ericsson and
Irons, 1994). Weak exogeneity is an indication of the long-run relationship between retail
and wholesale rates. (Strong causality refers to weak exogeneity in conjunction with shortrun Granger causality.) Wholesale rates would be expected to be weakly exogenous in the
wholesale-retail system because they are determined in the context of the wholesale
money market, with no reference to the retail market. On the other hand, the retail rate
would not be expected to be weakly exogenous in the wholesale-retail system but weakly
endogenous, because the retail rate should respond to shifts in the wholesale rate. In the
context of the Johansen methodology, weak exogeneity is evaluated by hypothesis tests on
the factor loading parameters in the a matrix. To test the hypothesis that retail rates are
weakly exogenous, the a parameter should not be signi®cantly different from 0 in the
wholesale equation, indicating that past disequilibria in the wholesale-retail system does
not signi®cantly affect the wholesale rate. The a parameter in the retail equation, on the
other hand, should be signi®cantly different from 0, indicating that past disequilibria in the
wholesale-retail system indeed has an impact on the current retail rate. The results of tests
for weak exogeneity are presented in the paper.
14
BARRY SCHOLNICK
Once tests on the number of cointegrating vectors as well as the weak exogeneity within
the system have been completed using the Johansen methodology, it is possible to examine
short-run error correction equations, in particular asymmetric error correction equations,
which are the key empirical test of this paper. Within the context of wholesale and retail
rates the simplest version of the standard error correction model can be written as
Drt ˆ c ‡ d1 ztÿ1 ‡ Dwt ‡ et
…5†
where r is the retail rate, w is the wholesale rate, and z is the stationary error correction
mechanism (ecm) term derived from the error term of the cointegration relationship
between r and w. In terms of the Johansen system above, the vector Xt is de®ned here as
…wt , rt †0 , such that the error correction term equals …w ÿ br†tÿk . Based on the weak
exogeneity tests conducted in the context of the Johansen methodology, the retail rate can
be taken as endogenous to the wholesale-retail system and to respond to exogenous shocks
to the market-determined wholesale rate. The error correction parameter, d1 , indicates the
extent to which the retail rate shifts back to the long-run equilibrium position following a
shock to the wholesale rate.
The asymmetric error correction models are similar to the standard ecm models except
that the ecm term is split into two terms, based on a dummy-variable procedure. The ®rst
type of asymmetry splits the ecm series based on whether the wholesale rate is increasing
or decreasing. This model can be written as
ÿ
Drt ˆ c ‡ d2 z‡
tÿ1 ‡ d3 ztÿ1 ‡ d4 Dwt ‡ et
…6†
where
z‡ ˆ z
if Dw40
z‡ ˆ 0
if Dw50
zÿ ˆ z
zÿ ˆ 0
if Dw50
if Dw40
…7†
and
…8†
The second type of asymmetry of interest concerns the case where the endogenous retail
rate is either above or below its long-run equilibrium position. The long-run equilibrium
within the cointegrating system occurs when the error correction term (z) is equal to 0.
Thus, it is possible to divide the error correction series into two, depending on whether the
retail rate is above or below its long-run equilibrium with respect to the wholesale rate.
When the retail rate is above (below) its long-run equilibrium, the error term, z, in the
long-run retail rate equation will be positive (negative). The structure of the second
asymmetric error correction model is the same as the ®rst:
ÿ
Drt ˆ c ‡ d5 z‡
tÿ1 ‡ d6 ztÿ1 ‡ d7 Dwt ‡ et
except that, in this case, the error correction series is split so that
…9†
INTEREST RATE ASYMMETRIES
15
z‡ ˆ z
z‡ ˆ 0
if z40
if z50
…10†
zÿ ˆ z
zÿ ˆ 0
if z50
if z40
…11†
and
The test of whether retail interest rates adjust asymmetrically is whether d2 is
signi®cantly different from d3 or whether d5 is signi®cantly different from d6 . These tests
are conducted using a Wald test. A ®nding that d2 is not signi®cantly different from d3
implies that there is no signi®cant asymmetry where the wholesale rate is increasing as
opposed to decreasing. Similarly, a ®nding that d5 is not signi®cantly different from d6
implies that there is no signi®cant asymmetry where the retail rate is above or below its
equilibrium level. These asymmetries are possible within the cointegration model, which
restricts the ecm series to be stationary (Granger and Lee, 1989).
4. Data and results
Data on most of the Canadian retail interest rates (on one-, three-, and ®ve-year mortgages;
one-, three-, and ®ve-year GICs, and saving deposit rates) as well as the relevant wholesale
interest rate data are taken from the CANSIM data CD-ROM, published by Statistics
Canada. All the Canadian data are weekly and, with one exception, cover the period 1982±
1995. All of the Canadian data series are reproduced in ®gures 1 to 4. Savings deposit rates
are the exception, in that the data covers the period from 1982 to the end of 1993. After this
date, the Canadian banks ceased to offer this particular product, although similar products
Figure 1. Canadian ®ve year rates.
16
BARRY SCHOLNICK
Figure 2. Canadian three year rates.
where introduced in the process of ®nancial innovation. (After 1993, the CANSIM savings
deposit data shows a constant interest rate of very close to 0.)
All the data are recorded on the Wednesday of each week. The data on mortgage,
savings deposit, and GIC rates are the average across the big six banks. Because of the
Figure 3. Canadian one year rates.
INTEREST RATE ASYMMETRIES
17
Figure 4. Canadian car loan and saving deposit rates.
concentrated nature of the banking system in Canada, usually all the banks quote the same
interest rate for each of these products at any given time. Information on interest rates on
new car loans was provided by the Bank of Canada, which collects weekly time series
information on new car interest rates charged by the big-six banks.
Figure 5. U.S. 30-year rates.
18
BARRY SCHOLNICK
The wholesale rate is taken as the relevant maturity money market interest rate, which
are either Canadian Treasury bond rates for maturities over one year or Canadian T bill
rates for maturities of one year or less. Three- or ®ve-year Treasury bond rates are used as
the wholesale rate for three- and ®ve-year mortgage rates, three-year car loan rates, and
three- and ®ve-year GIC rates. The one-year T bill rate is taken as the wholesale rate for
one-year mortgages and one-year GICs, and the three-month T bill rate is taken as a proxy
for the wholesale rate for savings deposits.
For comparison against both the longer-term Canadian products and the shorter-term
U.S. products examined in the literature, 30-year mortgage rates from the United States
also are examined here. The time period used is the same as that used for the Canadian data.
This data set is collected and published by the Freddie Mac organization. The mortgage
data set is the monthly average rate on ®xed-rate, 30-year mortgages. The wholesale rate is
taken as the 30-year U.S. government constant-maturity Treasury bills rate. The U.S. data
series are reproduced in ®gure 5.
Augmented Dickey Fuller (ADF) unit root stationarity tests are conducted on the levels
and ®rst differences of all the interest rate series. The results are reported in table 1. In all
Table 1. Augmented Dickey Fuller unit root tests
Level
Variable
No Trend
Trend
Difference
Mortgage 5
Mortgage 3
Mortgage 1
ÿ 0.71
ÿ 0.96
ÿ 0.69
ÿ 1.81
ÿ 1.44
ÿ 1.31
ÿ 8.69
ÿ 14.91
ÿ 8.02
GIC 5
GIC 3
GIC 1
ÿ 0.63
ÿ 0.89
ÿ 0.54
ÿ 2.02
ÿ 1.82
ÿ 1.44
ÿ 9.44
ÿ 13.75
ÿ 7.78
Savings deposit
Car loan
ÿ 1.30
ÿ 0.86
ÿ 1.81
ÿ 2.04
ÿ 15.90
ÿ 18.49
T
T
T
T
ÿ 2.45
ÿ 2.40
ÿ 2.09
ÿ 2.39
ÿ 2.70
ÿ 2.68
ÿ 2.25
ÿ 2.86
ÿ 15.36
ÿ 12.03
ÿ 15.62
ÿ 7.92
U.S. mortgage 30
U.S. T bill 30
ÿ 0.59
ÿ 0.71
ÿ 3.01
ÿ 2.85
ÿ 12.25
ÿ 11.30
95% Critical values
ÿ 2.86
ÿ 3.41
ÿ 2.86
bond 5
bond 3
bill 1
bill 3 m
Notes. Estimated equation:
dy ˆ m ‡ aytÿ1 ‡
X
ck dytÿk ‡ ut
Null hypothesis: a ˆ 0
Null hypothesis: Test of a unit root
Lag length (k) is determined by the highest signi®cant lag coef®cient (c) in the ADF equation.
19
INTEREST RATE ASYMMETRIES
cases, the null hypothesis can be rejected for the differenced series but cannot be rejected
for the levels series. It therefore can be concluded that the interest rate series are
nonstationary. This ®nding is common to the many papers in the literature using the
cointegration methodology to model interest rates. A standard procedure is used to
determine the lag length of these ADF tests. It can be noted however, that similar results are
found with the use of any lag from 0 to 12. The second stage is to test for cointegration
between each of the retail rates and the relevant wholesale rate. This is done by estimating
the two different statistics derived by Johansen and Juselius (1992), the rank and
eigenvalue statistics. To determine the lag length of the VAR for the Johansen and Juselius
(1992) procedure, the Schwartz criteria is used. The maximal eigenvalue and trace tests
evaluate the hypothesis of one or two cointegrating vectors. The results are given in table 2.
In all cases, both the eigenvalue and the trace tests provide evidence that it is not
possible to reject the hypothesis of one cointegrating vector between the wholesale and
retail rates (although, in the cases of savings deposits, car loans, and 30-year U.S.
mortgages, this can only be concluded at 5% rather than 1% signi®cance levels). With one
exception, it is possible to reject the hypothesis of two cointegrating vectors, which is
consistent with the hypothesis that a single nonstationary trend drives the stationary
cointegrating system. (In the case of the three-year GIC interest rate, the hypothesis of two
cointegrating vectors can be rejected at the 1% signi®cance level but not at the 5%
signi®cance level.)
The Johansen procedure results also provide evidence on weak exogeneity within the
different retail-wholesale cointegrating systems. Table 3 provides evidence on whether the
estimated parameters from the a matrix are signi®cantly different from 0. In all cases, the
Table 2. Johansen and Juselius (1992) cointegration tests
Maximal Eigenvalue Test
Trace Test
H0
H1
rˆ0
rˆ1
rˆ1
rˆ2
rˆ0
rˆ1
rˆ1
rˆ2
Mortgage 5ÐT bond 5
Mortgage 3ÐT bond 3
Mortgage 1ÐT bill 1
GIC 5ÐT bond 5
GIC 3ÐT bond 3
GIC 1ÐT bill 1
Savings depositÐT bill 3mth
Car-loanÐT bond 3
U.S. Mortgage 30ÐU.S. T bill 30
28.35**
46.42**
43.94**
22.54**
24.25**
62.32**
13.82*
13.29*
14.19*
3.58
3.60
2.85
3.46
4.22*
2.43
1.59
1.22
3.4
37.92**
50.02**
46.79**
26.00**
28.48**
64.76**
15.41*
14.53*
17.59**
3.58
3.60
2.85
3.46
4.22*
2.43
1.59
1.22
3.4
Notes. The reduced rank (r) of the following P matrix determines the number of cointegrating vectors:
DX t ˆ m ‡ G1 DXtÿ1 ‡ . . . ‡ Gkÿ1 DXtÿk‡1 ‡ PXtÿk ‡ e
Osterwald-Lenum (1992) critical values for cointegration tests:
**1% critical value.
*5% critical value.
VAR lag length is determined by Schwartz criteria.
20
BARRY SCHOLNICK
Table 3. Estimated alpha and beta from the Johansen cointegration procedure
Mortgage 5
Mortgage 3
Mortgage 1
GIC 5
GIC 3
GIC 1
Saving deposit
Car loan
U.S. Mortgage 30
Normalized b
a (retail)
w2 …H0 : a ˆ 0†
a (wholesale)
w2 …H0 a ˆ 0†
1.20
1.18
1.08
1.00
0.97
0.89
1.17
1.37
1.14
0.05
0.07
0.06
0.04
0.05
0.11
0.04
0.01
0.08
22.72[0.00]**
42.67[0.00]**
41.00[0.00]**
10.63[0.00]**
18.35[0.00]**
58.54[0.00]**
19.21[0.00]**
12.23[0.00]**
6.01[0.01]*
0.01
0.01
0.02
0.04
0.00
0.06
0.00
0.00
0.01
0.58[0.44]
0.64[0.42]
2.24[0.13]
6.06[0.01]*
0.27[0.60]
7.05[0.00]**
0.02[0.88]
0.08[0.77]
0.19[0.65]
Notes. Normalized b is from the estimated cointegrating vector of the wholesale rate on the retail rate.
Factor loading coef®cients a are from each of the retail and wholesale equations in the cointegrating system are
taken from the a matrix estimated by the Johansen methodology.
Test for weak exogeneity: If a(retail) is signi®cantly different from 0 and a(wholesale) is not signi®cantly
different from 0, then we cannot reject the hypothesis that the wholesale rate is weakly exogenous.
Table 4. Symmetric error correction mechanisms
D Mortgage 5
D GIC5
D Mortgage 3
D GIC3
ÿ 0.01
( ÿ 1.72)
0.00
( ÿ 1.58)
ÿ 0.01
( ÿ 1.94)
ÿ 0.01
( ÿ 1.81)
D Wholesale
0.15
(4.95)
0.13
(4.80)
0.18
(6.11)
0.16
(6.02)
ztÿ1
0.30
(9.76)
0.29
(10.34)
0.29
(9.79)
0.31
(11.41)
R2
dw
0.14
2.01
0.15
2.03
0.16
1.94
0.19
2.02
Constant
D Mortgage 1
D GIC1
D Car Loan
D Savings Deposit
D US Mortgage 30
ÿ 0.01
( ÿ 0.62)
ÿ 0.01
( ÿ 1.69)
ÿ 0.01
(1.53)
ÿ 0.01
( ÿ 2.44)
ÿ 0.02
( ÿ 2.21)
D Wholesale
0.19
(3.15)
0.15
(6.70)
0.12
(3.02)
0.26
(7.75)
0.69
(16.01)
ztÿ1
0.26
(4.29)
0.28
(11.84)
0.32
(7.56)
0.56
(16.07)
0.42
(7.29)
R2
dw
0.12
2.30
0.21
1.94
0.10
2.10
0.40
2.10
0.71
1.80
Constant
Notes. Estimated equation:
Drt ˆ c ‡ d1 ztÿ1 ‡ Dwt ‡ et
The t statistics are in parentheses.
21
INTEREST RATE ASYMMETRIES
Table 5. Asymmetric error correction mechanisms (wholesale increasing/decreasing)
D Mortgage 5
D GIC5
D Mortgage 3
D GIC3
ÿ 0.01
( ÿ 1.80)
0.00
(0.22)
ÿ 0.01
( ÿ 1.76)
0.00
(0.56)
D Wholesale
0.15
(4.93)
0.13
(4.86)
0.17
(6.04)
0.16
(6.05)
z‡
tÿ1
0.34
(6.10)
0.22
(4.26)
0.31
(5.90)
0.27
(5.62)
zÿ
tÿ1
0.26
(4.70)
0.36
(7.24)
0.27
(5.28)
0.34
(7.41)
R2
dw
0.14
2.02
0.16
2.04
0.16
1.95
0.20
2.02
Constant
D Mortgage 1
D GIC1
D Car Loan
ÿ 0.01
( ÿ 0.77)
ÿ 0.01
( ÿ 1.75)
ÿ 0.02
( ÿ 2.19)
0.00
(0.90)
ÿ 0.04
( ÿ 2.96)
D Wholesale
0.19
(3.12)
0.15
(6.63)
0.10
(2.57)
0.25
(7.68)
0.70
(16.06)
z‡
tÿ1
0.31
(2.76)
0.25
(6.60)
0.45
(7.19)
0.35
(5.43)
0.54
(6.20)
zÿ
tÿ1
0.22
(2.18)
0.31
(7.16)
0.14
(1.91)
0.68
(14.57)
0.30
(3.27)
R2
dw
0.12
2.30
0.21
1.95
0.42
2.07
0.72
1.72
Constant
0.11
1.99
D Savings Deposit
D US Mortgage 30
Estimated equation:
ÿ
Drt ˆ c ‡ d2 z‡
tÿ1 ‡ d3 ztÿ1 ‡ d4 Dwt ‡ et
where
z‡ ˆ z if
ÿ
z ˆ z if
Dw40
Dw50
or
or
z‡ ˆ 0
ÿ
z ˆ0
if
Dw50
if
Dw40
The t statistics are in parentheses.
hypothesis that the a parameter associated with the retail rate equation is equal to 0 can be
rejected. This implies that previous disequilibria in the wholesale-retail system feeds into
the determination of the retail rate. In all but two cases, it is possible to conclude that the a
parameter associated with the wholesale rate equation is not signi®cantly different from 0,
indicating that past disequilibria have no impact on the wholesale rate. In these cases it can
be concluded that the wholesale rate is weakly exogenous and that the retail rate is
endogenous to the wholesale-retail rate system. These conclusions are consistent with the
argument that the wholesale rate is determined in the money market with no reference to
the retail rate but that the wholesale rate in¯uences the retail rate. Table 3 also provides
estimates of the normalized b parameters from the Johansen equations, which estimate the
long-run equilibrium relationship between the wholesale and retail rates.
22
BARRY SCHOLNICK
Table 6. Asymmetric error correction mechanisms (retail above/below equilibrium)
D Mortgage 5
D GIC5
D Mortgage 3
D GIC3
ÿ 0.01
( ÿ 1.81)
0.00
(0.18)
ÿ 0.01
( ÿ 1.50)
ÿ 0.00
( ÿ 0.53)
D Wholesale
0.15
(4.92)
0.13
(4.86)
0.16
(5.39)
0.16
(6.06)
z‡
tÿ1
0.34
(6.08)
0.22
(4.28)
0.31
(5.51)
0.27
(5.51)
zÿ
tÿ1
0.26
(4.70)
0.37
(7.19)
0.29
(5.35)
0.35
(7.37)
R2
dw
0.14
2.02
0.16
2.04
0.17
1.92
0.20
2.02
Constant
D Mortgage 1
D GIC1
D Car Loan
ÿ 0.01
( ÿ 0.79)
ÿ 0.01
( ÿ 1.74)
ÿ 0.02
( ÿ 2.92)
0.00
(0.84)
ÿ 0.04
( ÿ 2.36)
D Wholesale
0.19
(3.12)
0.16
(6.65)
0.10
(2.54)
0.25
(7.62)
0.69
(16.08)
z‡
tÿ1
0.31
(2.78)
0.25
(6.51)
0.46
(7.09)
0.31
(4.67)
0.52
(5.36)
zÿ
tÿ1
0.22
(2.15)
0.31
(7.08)
0.13
(1.75)
0.71
(14.81)
0.29
(2.39)
0.21
2.81
0.11
1.99
0.42
1.99
0.72
2.06
1.76
Constant
R2 0.10
dw
D Savings Deposit
D U.S. Mortgage 30
Estimated equation:
ÿ
Drt ˆ c ‡ d5 z‡
tÿ1 ‡ d6 ztÿ1 ‡ d7 Dwt ‡ et
where
z‡ ˆ z if
ÿ
z ˆ z if
z40 or
z50 or
z‡ ˆ 0
ÿ
z ˆ0
if
z50
if
z40
The t statistics are in parentheses.
Once it is concluded that a cointegrating vector exists, it is possible to model the shortrun dynamics of the system using the error correction mechanism. Table 4 provides
evidence on the short-run speed of adjustment back to equilibrium for the standard
symmetric ecm equations. Tables 5 and 6 provide evidence on the two different types of
asymmetric error correction mechanisms. Table 5 examines tests for asymmetries when
the wholesale rate is increasing compared to when it is decreasing. Table 6 examines
whether asymmetries exist when the retail rate is above its long-run equilibrium with
respect to the wholesale rate compared to when it is below its long-run equilibrium.
The key results of this paper are provided in table 7. The table reports the Wald tests
of equality of the two asymmetric ecm terms reported for each product market in tables
5 and 6. The results indicate that, in most of the different product markets examined,
23
INTEREST RATE ASYMMETRIES
Table 7. Wald test of asymmetry: w2 …H0 coefficient on z‡ ˆ coefficient on zÿ †
Type of Asymmetry
Wholesale Increasing/Decreasinga
Retail Above/Below Equilibriumb
Mortgage 5
Mortgage 3
Mortgage 1
GIC 5
GIC 3
GIC 1
Savings deposit
Car loan
U.S. Mortgage 30
0.79[0.37]
0.28[0.60]
0.23[0.62]
2.95[0.09]
0.87[0.35]
0.62[0.43]
13.90[0.00]**
8.92[0.00]**
2.93[0.08]
0.81[0.35]
0.16[0.68]
0.26[0.60]
2.78[0.09]
0.94[0.33]
0.62[0.43]
20.14[0.00]**
8.91[0.00]**
1.59[0.20]
a
Test of whether d2 ˆ d3 from eq. (6) (table 5).
Test of whether d5 ˆ d6 from eq. (9) (table 6).
**1% critical value.
The p value is in brackets.
b
neither type of asymmetry was found to be signi®cant. In the cases of the Canadian car
loan and savings deposit market, both types of asymmetry where found to be
signi®cant; and that asymmetry was found to be in favor of the bank rather than the
consumer.
5. Discussion
The empirical results can be used to evaluate the different theoretical explanations for the
asymmetric interest rate adjustment. While the evidence here is not able to de®nitively
distinguish between the various theoretical explanations, the conclusions that interest rates
are either sticky upward, sticky downward, or not signi®cantly asymmetric can be used to
reject some of the various explanations in the different product markets examined. A
®nding of no asymmetry also will have implications for evaluating the possible impact of
the explanations raised here on the transmission mechanism of monetary policy.
In terms of the concentration hypothesis, because asymmetries exist in some products
provided by the big six Canadian banks but not in others, the evidence on this hypothesis is
mixed. In some Canadian product markets, concentration is associated with asymmetric
adjustment but in other product markets, no asymmetries are evident even though the
markets are concentrated.
Note that the evidence from the 30-year U.S. mortgage market should not be used to
evaluate the concentration hypothesis, because this is aggregate data across the United
States and most mortgage markets in the United States regional in nature. In Canada, on
the other hand, the national market can be considered the relevant market to examine
because the same banks compete across the entire country, and they advertise and offer the
same interest rates across the country. It therefore can be argued that it is possible to use
the country-level data examined here to evaluate the concentration hypothesis in the
Canadian context.
24
BARRY SCHOLNICK
The evidence here can also shed light on the consumer behavior hypotheses: that banks
have a degree of market power because of some element of consumer behavior (consumers
being unsophisticated or facing search or switching costs). The ®nding of no signi®cant
asymmetries in most of the longer-term markets is inconsistent with the hypotheses that
banks have market power. Hence, these ®ndings are inconsistent with the consumer
behavior explanations. However, it is not possible to reject the hypothesis that banks have
some degree of market power in the Canadian car loan and savings deposit markets, so it is
not possible to reject the hypothesis that the consumer behavior explanations are relevant
in these markets. (As noted earlier, neither is it possible to reject the relevance of the
concentration hypothesis in these two markets.)
One possible explanation for the ®ndings of no signi®cant asymmetries in most of the
longer-term markets is the argument that the consumer behavior issues discussed here
(unsophisticated consumers, switching costs, search costs) become less relevant in
markets for longer-term ®nancial products. This could explain why no signi®cant
asymmetries exist in the longer-term Canadian mortgage and GIC markets. Results from
the 30-year mortgage market in the United States support this argument. While much of
the existing literature (Diebold and Sharpe, 1990; Hannan and Berger, 1991; Hutchison,
1995; Rosen, 1995, and others) has detected asymmetries in many shorter-term U.S.
products, no signi®cant asymmetry could be detected here in the 30-year U.S. mortgage
series. Therefore, these results indicate that issues of search cost, switching cost, or the
sophistication of consumers could becomes less relevant as the maturity of the product
increases.
A related way of interpreting these results is in terms of the opportunity cost of not
searching for a better interest rate. Opportunity cost of not searching is related to both the
maturity and size of a ®nancial product. In the products where signi®cant asymmetries are
detected, it is possible that the opportunity cost of not searching is relatively low, giving
the banks some degree of market power. Savings deposits, for example, typically may
involve shorter maturities as well as smaller amounts relative to some of the other
products, such as GICs, where no asymmetries are detected.
Note that, in all the markets examined here, in no case was it concluded that a signi®cant
asymmetry existed in favor of the consumer; that is, loan rates sticky upward or deposit
rates sticky downward. It thus is possible to reject the negative customer reaction
hypothesis proposed by Hannan and Berger (1991).
The ®nal theoretical explanation for asymmetric adjustmentÐthe adverse selection
hypothesis of Stiglitz and WeissÐapplies only to loan markets. The ®ndings presented
here of no asymmetric adjustment in both the Canadian and U.S. mortgage markets are not
consistent with the Stiglitz and Weiss hypothesis, which predicts that loan rates should be
signi®cantly sticky upward. Furthermore, the ®nding in the car loan market that rates are
sticky downward also is inconsistent with the Stiglitz and Weiss hypothesis.
6. Conclusions
A common empirical ®nding in the literature is that short-term consumer interest rates in
the United States adjust asymmetrically; that is, they increase at a speed different from the
INTEREST RATE ASYMMETRIES
25
speed at which they decrease. This paper examines whether signi®cant asymmetries exist
in consumer ®nance product markets that are very different from those examined in the
literature. In particular, this paper examines whether signi®cant asymmetries exist in
longer-term loan and deposit markets in Canada and the United States.
The empirical evidence provided here is that no signi®cant asymmetries could be
detected in the markets for longer-term (one-, three- and ®ve-year) mortgage and longerterm (one-, three- and ®ve-year) ®xed-interest deposit (GIC) rates in Canada or in 30-year
mortgage rates in the United States. On the other hand, signi®cant asymmetries in favor of
the banks can be found in the markets for car loans and savings deposits in Canada. These
differences between the different product markets imply that the different theoretical
explanations proposed in the literature to explain interest rate asymmetries in shorter-term
products in the United States can be considered consistent with the data only in, at most, a
subset of ®nancial products used by consumers in Canada and the United States. The data
and explanations of interest rate asymmetries from the United States literature would
appear to some extent to be market speci®c and cannot be generalized easily to different
types of consumer ®nancial products in different countries.
The importance of this ®nding lies in evaluating possible distortions to the monetary
policy transmission mechanism from the asymmetric adjustment of consumer interest
rates. While monetary policy can be transmitted to the economy in many ways, one
important channel is through consumer interest rates. If distortions such as the asymmetric
adjustment found in short-term U.S. rates are widespread across different consumer
®nancial products, then such distortions could become a concern to macro-economic and
monetary policy makers. The evidence provided here, that signi®cant asymmetries exist in
some but not all the longer-term product markets, indicates that the impact of interest rate
asymmetries on the transmission mechanism is less than it could be.
Acknowledgments
Funding for this project was provided by the Southam Fellowship, Faculty of Business,
University of Alberta. I would like to thank two anonymous referees for their very useful
comments.
References
Ausubel, Lawrence. ``The Failure of Competition in the Credit Card Market.'' American Economic Review 81,
no. 1 (1991), 50±81.
Berger, Allen and Gregory Udell. ``Some Evidence on the Empirical Signi®cance of Credit Rationing.'' Journal
of Political Economy 100 (1992), 5.
Beauchesene, Eric. ``Canadians Shift to Longer Term Mortgages.'' Southam Newspapers, March 21, 1998.
Calem, Paul, and Loretta Mester. ``Consumer Behavior and the Stickiness of Credit-Card Interest Rates.''
American Economic Review 85 (1995), 1327±1336.
Campbell, John, and Robert Shiller. ``Cointegration and Tests of Present Value Models.'' Journal of Political
Economy 95 (1987), 1063±1088.
26
BARRY SCHOLNICK
Diebold, Francis, and Steven Sharpe. ``Post-Deregulation Deposit Rate Pricing: The Multivariate Dynamics.''
Journal of Business and Economics Statistics 51 (1990), 393±414.
Engsted, T., and C. Tanggaard. ``Cointegration and the U.S. Term Structure.'' Journal of Banking and Finance
18 (1994), 167±181.
Engle, R.F., and Clive Granger. ``Cointegration and Error Correction: Representation, Estimation and Testing.''
Econometrica 55 (1987), 251±276.
Ericsson, Neil. ``Cointegration, Exogeneity and Policy Analysis: An Overview.'' Journal of Policy Modeling 14,
no. 3 (1992), 251±280.
Ericsson, Neil, and John Irons. Testing Exogeneity. Oxford: Oxford University Press, 1994.
Granger, Clive, and T. Lee. ``Investigation of Production, Sales and Inventory Relationships Using
Multicointegration and Non-symmetric Error Correction Models.'' Journal of Applied Econometrics 4
(1889), s145±s159.
Granger, Clive, and Timo Terasvirta. Modelling Nonlinear Economic Relationships. Oxford: Oxford University
Press, 1993.
Hall, A., H. Anderson, and Clive Granger. ``Treasury Bill Yield Curves and Cointegration.'' Review of
Economics and Statistics 74 (1992), 116±126.
Hannan, and Timothy. ``Asymmetric Price Rigidity and the Responsiveness of Customers to Price Changes: The
Case of Deposit Interest Rates.'' Journal of Financial Services Research 8 (1994), 257±267.
Hannan, Timothy, and Alan Berger. ``The Rigidity of Prices. Evidence from the Banking Industry.'' American
Economic Review 81 (1991), 938±945.
Heffernan, Shelagh. ``Modelling British Interest Rate Adjustment: An Error Correction Approach.'' Economica
64 (1997), 211±311.
Hutchison, David. ``Retail Bank Deposit Pricing: An Intertemporal Asset Pricing Approach.'' Journal of Money
Credit and Banking 27, no. 1, (1995), 217±231.
Johansen, Soren. ``Estimation and Hypothesis Testing of Cointegrating Vectors in Gaussian Vector
Autoregressive Models.'' Econometrica 59, no. 6 (1991), 1551±1580.
Johansen, Soren, and Juselius, K. ``Testing Structural Hypothesis in a Multivariate Cointegration Analysis of the
PPP and the UIP for the UK.'' Journal of Econometrics 53 (1992), 211±244.
Lee, T.-H., and F. Koray. ``Uncertainty in Sales and Inventory Behavior in the U.S. Trade Sectors.'' Canadian
Journal of Economics 27 (1994), 129±142.
Moore, George, Richard Porter, and David Small. ``Modeling the Disaggregated Demands for M2 and M1: The
U.S. Experience in the 1980s.'' In: P. Hooper, K. Johnson, D. Kohn, D. Lindsey, R. Porter, R. Tyron, (Eds.),
Financial Sectors. in Open Economies: Empirical Analysis and Policy Issues. Washington, DC: Board of
Governors of the Federal Reserve System, 1990.
Mester, Loretta, and Anthony Saunders. ``When Does the Prime Rate Change?'' Journal of Banking and
Finance 19 (1995), 743±764.
Neumark, D., and S. Sharpe. ``Market Structure and the Nature of Price Rigidity: Evidence from the Market for
Consumer Deposits.'' Quarterly Journal of Economics 107 (1992), 657±680.
Osterwald-Lenum, M. ``A Note with Quantiles of the Asymptotic Distributions of the Maximum Likelihood
Cointegration Test Statistics.'' Oxford Bulletin of Economics and Statistics 54 (1992), 461±471.
Royal Bank Financial Group. Three Cs of Canadian Banking: Conduct, Competition, Concentration, Royal Bank
of Canada, Toronto, 1996, pp. 1±23.
Rosen, Richard. ``What Goes up Must Come Down? Asymmetries and Persistence in Bank Deposit Rates.''
Indiana University working paper, 1995.
Scholnick, Barry. ``Asymmetric Adjustment of Commercial Bank Interest Rates: Evidence from Malaysia and
Singapore.'' Journal of International Money and Finance 15, no. 3 (1996), 485±496.
Shaffer, Sherrill. ``A Test of Competition in Canadian Banking.'' Journal of Money, Credit and Banking 25, no.
1 (1993), 49±61.
Shaffer, Sherrill. ``Bank Competition in Concentrated Markets.'' Federal Reserve Bank of Philadelphia Business
Review (March±1994), 3±16.
Stiglitz, Joseph, and Andrew Weiss. ``Credit Rationing in Markets with Imperfect Information.'' American
Economic Review 71, (1981), 393±410.