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Tests of the Expectations Hypothesis: Resolving the Campbell-Shiller Paradox

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  • Thornton, Daniel L.

Abstract

One of the more puzzling results in the expectations hypothesis (EH) testing literature is the Campbell-Shiller paradox (CSP). In an influential paper, Campbell and Shiller (1991) found that "the slope of the term structure almost always gives a forecast in the wrong direction for the short-term change in the yield on the longer bond, but gives a forecast in the right direction for long-term changes in short rates." This paper provides an econometric resolution to the CSP. Specifically, it shows that, by their construction, these tests can generate results consistent with the CSP if the EH does not hold-whatever the reason. Monte Carlo experiments confirm that this explanation can account for Campbell and Shiller's paradoxical results for most pairings of short-term and long-term rates considered.

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Bibliographic Info

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

Volume (Year): 38 (2006)
Issue (Month): 2 (March)
Pages: 511-542

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Handle: RePEc:mcb:jmoncb:v:38:y:2006:i:2:p:511-542

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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Cited by:
  1. Yu-chin Chen & Kwok Ping Tsang, 2013. "What Does the Yield Curve Tell Us about Exchange Rate Predictability?," The Review of Economics and Statistics, MIT Press, vol. 95(1), pages 185-205, March.
  2. Matteo Modena, 2008. "The Term Structure and the Expectations Hypothesis: a Threshold Model," Working Papers 2008_36, Business School - Economics, University of Glasgow.
  3. Abbassi, Puriya & Linzert, Tobias, 2012. "The effectiveness of monetary policy in steering money market rates during the financial crisis," Journal of Macroeconomics, Elsevier, vol. 34(4), pages 945-954.
  4. Clemens J.M. Kool & Daniel L. Thornton, 2012. "How effective is central bank forward guidance?," Working Papers 2012-063, Federal Reserve Bank of St. Louis.
  5. Daniel L. Thornton, 2004. "Testing the expectations hypothesis: some new evidence for Japan," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 21-40.
  6. Silva Lopes, Artur C. B. da & Monteiro, Olga Susana, 2008. "Short and long run tests of the expectations hypothesis: the Portuguese case," MPRA Paper 12001, University Library of Munich, Germany.
  7. Erdenebat Bataa & Dong H. Kim & Denise R. Osborn, 2007. "Expectations Hypothesis Tests in the Presence of Model Uncertainty," Discussion Paper Series 0703, Institute of Economic Research, Korea University.
  8. Pasquale Della Corte & Lucio Sarno & Daniel L. Thornton, 2007. "The expectation hypothesis of the term structure of very short-term rates: statistical tests and economic value," Working Papers 2006-061, Federal Reserve Bank of St. Louis.
  9. M. Hadzi-Vaskov & C.J.M. Kool, 2006. "The importance of interest rate volatility in empirical tests of uncovered interest parity," Working Papers 06-16, Utrecht School of Economics.
  10. repec:use:tkiwps:1205 is not listed on IDEAS
  11. Modena, Matteo, 2008. "Yield curve, time varying term premia, and business cycle fluctuations," MPRA Paper 8873, University Library of Munich, Germany.
  12. Massimo Guidolin & Daniel L. Thornton, 2010. "Predictions of short-term rates and the expectations hypothesis," Working Papers 2010-013, Federal Reserve Bank of St. Louis.
  13. Azar, Samih Antoine, 2010. "Testing the Expectations Hypothesis on Corporate Bond Yields," Review of Applied Economics, Review of Applied Economics, vol. 6(1-2).
  14. Bulkley, George & Harris, Richard D.F. & Nawosah, Vivekanand, 2011. "Revisiting the expectations hypothesis of the term structure of interest rates," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1202-1212, May.
  15. 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.

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