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Rethinking cointegration and the expectation hypothesis of the term structure

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  • Li, Jing
  • Davis, George

Abstract

Empirical investigations of the expectations hypothesis of the term structure often test the stationarity on the yield spread. We show that as the term difference increases this stationarity breaks down even under the most favorable assumption with regard to the risk premium. As a result, these cointegration tests are inappropriate. We conduct Monte Carlo simulations and provide empirical evidences that the frequency with which the data fail to reject no cointegration increases as the term difference increases. This finding remains robust after we account for a proxy for risk premium, asymmetries, and employ a new augmented error correction model that allows for time-varying error correction terms.

Suggested Citation

  • Li, Jing & Davis, George, 2017. "Rethinking cointegration and the expectation hypothesis of the term structure," Journal of Empirical Finance, Elsevier, vol. 44(C), pages 177-189.
    • Handle: RePEc:eee:empfin:v:44:y:2017:i:c:p:177-189
    DOI: 10.1016/j.jempfin.2017.09.011
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    Cited by:

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    2. Vides, José Carlos & Golpe, Antonio A. & Iglesias, Jesús, 2020. "The EHTS and the persistence in the spread reconsidered. A fractional cointegration approach," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 124-137.

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    More about this item

    Keywords

    Cointegration; Term structure; Expectation hypothesis; Error correction model;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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