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Time-variation in term premia: International survey-based evidence

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  • Jongen, Ron
  • Verschoor, Willem F.C.
  • Wolff, Christian C.P.

Abstract

Using a large, previously unexplored data set of survey-based interest rate forecasts that covers a broad range of countries, this paper re-examines the expectations hypothesis of the term structure of interest rates. We find that survey-based interest rate forecasts outperform not only a random walk forecast, but also outperform forecasts from forward rates. When using these superior survey-based forecasts in a modified expectations hypothesis test, the expectations hypothesis is rejected for fewer countries, at lower significance levels, and has greater explanatory power than when using a traditional forward rates-based test. We furthermore document strong time-variation in the term premia, which is an important reason why the traditional expectations hypothesis test is rejected so frequently. This time-variation seems to arise from the changing attitudes towards risk among market participants and as a compensation for the change in liquidity in the term structure. Finally, we find that generalizing findings from earlier U.S. studies to other countries may lead to bias in the true economic relationships in these countries.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 30 (2011)
Issue (Month): 4 (June)
Pages: 605-622

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Handle: RePEc:eee:jimfin:v:30:y:2011:i:4:p:605-622

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Web page: http://www.elsevier.com/locate/inca/30443

Related research

Keywords: Expectations hypothesis Term structure Time-varying term premia Interest rate expectations Rationality Survey data;

References

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Cited by:
  1. Jitmaneeroj, Boonlert & Wood, Andrew, 2013. "The expectations hypothesis: New hope or illusory support?," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 1084-1092.
  2. Chen, Cathy Yi-Hsuan & Kuo, I-Doun & Chiang, Thomas C., 2014. "What explains deviations in the unbiased expectations hypothesis? Market irrationality vs. the peso problem," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 30(C), pages 172-190.
  3. Chen, Qianying, 2011. "Exchange rate dynamics, expectations, and monetary policy," Discussion Paper Series 1: Economic Studies 2011,18, Deutsche Bundesbank, Research Centre.
  4. Galvao, Ana Beatriz & Costa, Sonia, 2013. "Does the euro area forward rate provide accurate forecasts of the short rate?," International Journal of Forecasting, Elsevier, vol. 29(1), pages 131-141.

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