A Flexible Non Linear Model to Test the Expectation Hypothesis of Interest Rates
AbstractConventional approaches to examining the expectation hypothesis of interest rates assume a parametric linear specification among variables. In contrast, this paper tests the hypothesis using a flexible nonlinear inference approach proposed by Hamilton (2001). We examine the impact of the nonlinearity of interest rates to explain the variability of risk premia on market rates. It is assumed that the term structure of interest rates can be identified by two factors, the risk-free rate and its volatility. The results of the linearity test against nonlinear alternatives suggest that there is clear evidence of nonlinearity. Our empirical study shows that correctly accounting for the nonlinearity of the term structure of interest rates may explain the variability of risk premia and the specific characteristics of interest rate dynamics on the U.S. market.
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Bibliographic InfoArticle provided by AccessEcon in its journal Economics Bulletin.
Volume (Year): 30 (2010)
Issue (Month): 3 ()
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Term structure of interest rates; Non linearity; expectation hypothesis; flexible models.;
Find related papers by JEL classification:
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
- E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
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- Bekaert, Geert & Hodrick, Robert J. & Marshall, David A., 1997.
"On biases in tests of the expectations hypothesis of the term structure of interest rates,"
Journal of Financial Economics,
Elsevier, vol. 44(3), pages 309-348, June.
- Geert Bekaert & Robert J. Hodrick & David Marshall, 1996. "On biases in tests of the expectations hypothesis of the term structure of interest rates," Working Paper Series, Issues in Financial Regulation WP-96-3, Federal Reserve Bank of Chicago.
- Geert Bekaert & Robert J. Hodrick & David A. Marshall, 1996. "On Biases in Tests of the Expecations Hypothesis of the Term Structure Of Interest Rates," NBER Technical Working Papers 0191, National Bureau of Economic Research, Inc.
- Dong-Hyun Ahn & Robert F. Dittmar, 2002. "Quadratic Term Structure Models: Theory and Evidence," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 243-288, March.
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