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Testing the expectations hypothesis of the term structure with permanent-transitory component models

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  • Casalin, Fabrizio
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    Abstract

    This study proposes a new application of Permanent-Transitory Component Models (PTCMs) to test the Expectation Hypothesis of the Term Structure (EHTS). Unlike previous approaches, tests based on PTCMs can simultaneously detect departures from rational expectations and time varying term premia. We set out analytically and empirically the links across previous tests and PTCMs. We also show that PTCMs identify an additional restriction for rational expectations, on top of the one-to-one relationship between forward and spot rates, that must be imposed in estimations of term premia. Data for the short-end of the US term structure suggest that both factors contribute to the rejection of the EHTS. Moreover, the empirical estimates of term premia are persistent and exhibit sign fluctuations. Their stochastic properties depend crucially on whether the additional restriction for rational expectations is imposed in estimation.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 37 (2013)
    Issue (Month): 8 ()
    Pages: 3192-3203

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    Handle: RePEc:eee:jbfina:v:37:y:2013:i:8:p:3192-3203

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Term structure of interest rates; Kalman filter; MC simulations;

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