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Estimation of the specification error in the expectations theory of the term structure

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Paul A. Johnson

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Abstract

This paper asks, 'how false is the expectations theory of the term structure?’. Most previous work has asked, 'is the expectations theory true?’ and finds that it is not. The goal here is to gauge the economic importance of these answers in the negative by estimating the specification error in the expectations theory. The variance of the estimated specification error (suitably normalized) provides a metric for assessing the validity of the model. I find that, while the expectations theory can be rejected, the importance of the rejection is much less than that implied by previous studies, so that the theory may still be a useful tool for understanding the relationships between interest rates at different maturities.

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Publisher Info
Article provided by Taylor and Francis Journals in its journal Applied Economics.

Volume (Year): 29 (1997)
Issue (Month): 9 (September)
Pages: 1239-1247
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Handle: RePEc:taf:applec:v:29:y:1997:i:9:p:1239-1247

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. John Y. Campbell & Robert J. Shiller, 1988. "Cointegration and Tests of Present Value Models," NBER Working Papers 1885, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Shea, Gary S, 1992. "Benchmarking the Expectations Hypothesis of the Interest-Rate Term Structure: An Analysis of Cointegration Vectors," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(3), pages 347-66, July.
  3. Johnson, Paul A, 1994. "On the Number of Common Unit Roots in the Term Structure of Interest Rates," Applied Economics, Taylor and Francis Journals, vol. 26(8), pages 815-20, August.
  4. Engsted, Tom & Tanggaard, Carsten, 1994. "Cointegration and the US term structure," Journal of Banking & Finance, Elsevier, vol. 18(1), pages 167-181, January. [Downloadable!] (restricted)
  5. Peter C.B. Phillips, 1985. "Understanding Spurious Regressions in Econometrics," Cowles Foundation Discussion Papers 757, Cowles Foundation, Yale University. [Downloadable!]
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  6. Robert J. Shiller & J. Huston McCulloch, 1987. "The Term Structure of Interest Rates," NBER Working Papers 2341, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Campbell, John Y & Shiller, Robert J, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Blackwell Publishing, vol. 58(3), pages 495-514, May. [Downloadable!] (restricted)
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  8. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Cowles Foundation Discussion Papers 667, Cowles Foundation, Yale University. [Downloadable!]
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  9. Mankiw, N Gregory & Miron, Jeffrey A, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, MIT Press, vol. 101(2), pages 211-28, May. [Downloadable!] (restricted)
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  10. Hall, Anthony D & Anderson, Heather M & Granger, Clive W J, 1992. "A Cointegration Analysis of Treasury Bill Yields," The Review of Economics and Statistics, MIT Press, vol. 74(1), pages 116-26, February. [Downloadable!] (restricted)
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