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Explaining the Failures of the Term Spread Models of the Rational Expectations Hypothesis of the Term Structure

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Author Info
Tzavalis, Elias
Wickens, Michael R

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Abstract

Contrary to the predictions of the rational expectations hypothesis of the term structure of interest rates, empirical evidence suggests that the term spread between long and short rates fails to forecast future movements of long-term rates although its forecasts of future short-term rates are in the correct direction. In this paper, the authors show that this puzzling behavior of the term spread alone can be explained by a time-varying term premium that is correlated with the term spread. Once this is accounted for, neither expression of the expectations hypothesis is against the predictions of the theory. Copyright 1997 by Ohio State University Press.

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Publisher Info
Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 29 (1997)
Issue (Month): 3 (August)
Pages: 364-80
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Handle: RePEc:mcb:jmoncb:v:29:y:1997:i:3:p:364-80

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  1. Christian Mose Nielsen, 2005. "The information content of the term structure of interest rates about future inflation – an illustration of the importance of accounting for a time-varying real interest rate and inflation risk prem," Money Macro and Finance (MMF) Research Group Conference 2005 86, Money Macro and Finance Research Group. [Downloadable!]
  2. Silva Lopes, Artur C. & Monteiro, Olga Susana, 2007. "The Expectations Hypothesis of the Term Structure: Some Empirical Evidence for Portugal," MPRA Paper 6310, University Library of Munich, Germany, revised 14 Dec 2007. [Downloadable!]
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  3. Gianna Boero & Costanza Torricelli, 1999. "The Information in the Term of Structure: further Results for Germany," Working Paper CRENoS 199912, Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia. [Downloadable!]
  4. Modena, Matteo, 2008. "Yield curve, time varying term premia, and business cycle fluctuations," MPRA Paper 8873, University Library of Munich, Germany. [Downloadable!]
  5. Rasmus Pilegaard & Alain Durre & Snorre Evjen, 2003. "Estimating risk premia in money market rates," Working Paper Series 221, European Central Bank. [Downloadable!]
  6. Daniel L. Thornton, 2005. "Predictions of short-term rates and the expectations hypothesis of the term structure of interest rates," Working Papers 2004-010, Federal Reserve Bank of St. Louis. [Downloadable!]
  7. Peter Reinhard Hansen, 2000. "Structural Changes in the Cointegrated Vector Autoregressive Model," Working Papers 2000-20, Brown University, Department of Economics. [Downloadable!]
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  8. Peter Reinhard Hansen, 2000. "Structural Breaks in the Cointegrated Vector Autoregressive Model," Econometric Society World Congress 2000 Contributed Papers 1240, Econometric Society. [Downloadable!]
  9. Fabrizio Casalin, 2007. "Single Equation Models, Co-Integration and the Expectations Hypothesis of the Term Structure of Interest Rates," Working Papers 110, University of Milano-Bicocca, Department of Economics, revised 2007. [Downloadable!]
  10. Fung, Ben & Mitnick, Scott & Remolona, Eli, 1999. "Uncovering Inflation Expectations and Risk Premiums From Internationally Integrated Financial Markets," Working Papers 99-6, Bank of Canada. [Downloadable!]
  11. John Anderson, 2003. "A Test of Weak-Form Market Efficiency in Australian Bank Bill Futures Calendar Spreads," School of Economics and Finance Discussion Papers and Working Papers Series 134, School of Economics and Finance, Queensland University of Technology. [Downloadable!]
  12. Toni Gravelle & James C. Morley, 2005. "A Kalman filter approach to characterizing the Canadian term structure of interest rates," Applied Financial Economics, Taylor and Francis Journals, vol. 15(10), pages 691-705, June. [Downloadable!] (restricted)
  13. Thomas J. Flavin & Michael R. Wickens, 2001. "A Risk Management Approach to Optimal Asset Allocation," Economics, Finance and Accounting Department Working Paper Series n1080301, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth. [Downloadable!]
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  14. Boero, G. & Torricelli, C., 1998. "Tests of the Expectations Hypothesis and Policy Reaction to the Term Spread: Some Comparative Evidence," The Warwick Economics Research Paper Series (TWERPS) 512, University of Warwick, Department of Economics. [Downloadable!]
  15. Basma Bekdache & Christopher F. Baum, 1998. "Modeling fixed income excess returns," Boston College Working Papers in Economics 409, Boston College Department of Economics, revised 14 Apr 2000. [Downloadable!]
  16. Daniel L. Thornton, 2004. "Tests of the expectations hypothesis: resolving the Campbell-Shiller paradox," Working Papers 2003-022, Federal Reserve Bank of St. Louis. [Downloadable!]
  17. Flavin, Thomas & Wickens, Michael R, 2002. "Macroeconomic Influences on Optimal Asset Allocation," CEPR Discussion Papers 3144, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  18. Modena, Matteo, 2008. "The term structure and the expectations hypothesis: a threshold model," MPRA Paper 9611, University Library of Munich, Germany. [Downloadable!]
  19. Osmani Teixeira de Carvalho Guillén & Benjamin M. Tabak?, 2007. "Characterizing The Brazilian Term Structure Of Interest Rates," Anais do XXXV Encontro Nacional de Economia [Proceedings of the 35th Brazilian Economics Meeting] 108, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics]. [Downloadable!]
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  20. Michael Gordon, 2003. "Estimates of time-varying term premia for New Zealand and Australia," Reserve Bank of New Zealand Discussion Paper Series DP2003/06, Reserve Bank of New Zealand. [Downloadable!]
  21. Christian Mose Nielsen, 2007. "Does the choice of interest rate data matter for the results of tests of the expectations hypothesis - some results for the UK," Money Macro and Finance (MMF) Research Group Conference 2006 132, Money Macro and Finance Research Group. [Downloadable!]
  22. Gianna Boero & Costanza Torricelli, 2002. "The information in the term structure of German interest rates," European Journal of Finance, Taylor and Francis Journals, vol. 8(1), pages 21-45, March. [Downloadable!] (restricted)
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