THE FINANCIAL REVIEW VOL. 32 No. zyxw 3 NOVEMBER 1997 zyx Pp. 821-844 zy The Causality Effects of the Federal Reserve's Monetary Policy on U.S. and Eurodollar Interest Rates Mbodja Mougoue' and John Wagster" Abstract zyxw Previous studies argue that U.S. interest rates will be- come more sensitive to changes in eurodollarrates as interna- tional financial-market integration increases. However, the empirical results of these studies are suspect because they select their subperiods in an ad hoc manner and ignore the different trading hours of the U.S. and London markets. This study adjusts for the markets' different trading hours and uses Goldfeld and Quandt's switching regression technique to show that the causal relation between U.S. CD rates and eurodollar rates is impacted by the Federal Re- serve's monetary policy. Because the latest subperiod exhib- its uni-directional causality (i.e., U.S. interest rates cause changes in eurodollar rates), the results cast doubt on the implicit assumption made in the literature that interest-rate causality is only affected by increasing levels of financial- market integration. Introduction The international transmission of short-term interest rates is a crucial issue to financial market participants, busi- ness managers, and national monetary authorities. For ex- ample, the ability of international investors to maximize their returns without the knowledge of international inter- est rate relationships and how they respond to exogenous *Wayne State University, Detroit, MI 48202 The authors gratefully thank an anonymous referee, Jean-Pierre Urbain and Peggy Swanson for their valuable comments. The authors also thank seminar participants at the 1994 European Financial Management Conference, the 1994 Southern Finance Association meeting, and at Wayne State University. Any remaining errors are the sole responsibility of the authors. John Wagster acknowledges support from the School of Business Administration at Wayne State University. 821