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The rational expectations hypothesis and the cross-section of bond yields

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  • Richard Harris

Abstract

In the context of the bond market, empirical tests of the rational expectations hypothesis (REH) have without exception been tests of the time-series properties of interest rates. However, the REH also imposes restrictions on the cross-section of bond yields at each point in time. This study tests these restrictions using the Fama and MacBeth repeated cross-section regression procedure. Specifically, a long series of monthly cross-section regressions is estimated using zero coupon bond yield data for maturities from two months to thirty-five years. The REH is tested using the time-series average of the estimated slope parameter in the cross-section regressions. The maturity-specific risk premium is proxied by the time-series volatility of excess returns for each bond maturity. Time-variation in the risk premium is allowed for through time-variation in the volatility of excess returns, and in the market price of risk. While the risk premium proxy is significant in explaining the cross-section of excess returns, the REH is very strongly rejected.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 14 (2004)
Issue (Month): 2 ()
Pages: 105-112

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Handle: RePEc:taf:apfiec:v:14:y:2004:i:2:p:105-112

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  1. Chan, Louis K C & Hamao, Yasushi & Lakonishok, Josef, 1991. " Fundamentals and Stock Returns in Japan," Journal of Finance, American Finance Association, vol. 46(5), pages 1739-64, December.
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  4. N. Gregory Mankiw & Lawrence H. Summers, 1987. "Do Long-Term Interest Rates Overreact to Short-Term Interest Rates?," NBER Working Papers 1345, National Bureau of Economic Research, Inc.
  5. N. Gregory Mankiw & Matthew D. Shapiro, 1985. "Do We Reject Too Often? Small Sample Properties of Tests of Rational Expectations Models," NBER Technical Working Papers 0051, National Bureau of Economic Research, Inc.
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  7. Campbell, John Y & Shiller, Robert J, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 495-514, May.
  8. Bams, Dennis & Wolff, Christian C. P., 2003. "Risk premia in the term structure of interest rates: a panel data approach," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 13(3), pages 211-236, July.
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Cited by:
  1. Arielle Beyaert & Juan Jose Perez-Castejon, 2009. "Markov-switching models, rational expectations and the term structure of interest rates," Applied Economics, Taylor & Francis Journals, vol. 41(3), pages 399-412.

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