IDEAS home Printed from https://ideas.repec.org/p/bay/rdwiwi/15152.html
   My bibliography  Save this paper

Mean-Variance Cointegration and the Expectations Hypothesis

Author

Listed:
  • Strohsal, Till
  • Weber, Enzo

Abstract

The present work provides an economic explanation of a well-known (seeming) violation of the expectations hypothesis of the term structure (EHT) - the frequent finding of unit roots in interest rate spreads. We derive from EHT that the nonstationarity stems from the holding premium, which is hence cointegrated with the spread. We model the premium as being proportional to the integrated variance of excess returns and further propose a cointegration test. Simulating the distribution of the test statistic we actually find cointegration relations between premia and spreads in US data. The EHT appears to perform better than previously thought.

Suggested Citation

  • Strohsal, Till & Weber, Enzo, 2010. "Mean-Variance Cointegration and the Expectations Hypothesis," University of Regensburg Working Papers in Business, Economics and Management Information Systems 442, University of Regensburg, Department of Economics.
    • Handle: RePEc:bay:rdwiwi:15152
    as

    Download full text from publisher

    File URL: https://epub.uni-regensburg.de/15152/1/MeanVarianceCointegration.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-131, February.
    2. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    3. Hess, Alan C & Kamara, Avraham, 2005. "Conditional Time-Varying Interest Rate Risk Premium: Evidence from the Treasury Bill Futures Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(4), pages 679-698, August.
    4. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
    5. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-370, March.
    6. Hiona Balfoussia & Mike Wickens, 2007. "Macroeconomic Sources of Risk in the Term Structure," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(1), pages 205-236, February.
    7. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
    8. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(4), pages 627-627, November.
    9. N. Gregory Mankiw & Jeffrey A. Miron, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(2), pages 211-228.
    10. Campbell, John Y & Shiller, Robert J, 1987. "Cointegration and Tests of Present Value Models," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 1062-1088, October.
    11. Nikolaos Kourogenis & Nikitas Pittis, 2008. "Testing for a unit root under errors with just barely infinite variance," Journal of Time Series Analysis, Wiley Blackwell, vol. 29(6), pages 1066-1087, November.
    12. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    13. Kim, Kiwhan & Schmidt, Peter, 1993. "Unit root tests with conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 59(3), pages 287-300, October.
    14. Shiqing Ling & W. K. Li & Michael McAleer, 2003. "Estimation and Testing for Unit Root Processes with GARCH (1, 1) Errors: Theory and Monte Carlo Evidence," Econometric Reviews, Taylor & Francis Journals, vol. 22(2), pages 179-202.
    15. Robert A. Connolly & Z. Nuray Güner & Kenneth N. Hightower, 2007. "Evidence on the Extent and Potential Sources of Long Memory in U.S. Treasury Security Returns and Yields," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2‐3), pages 689-702, March.
    16. John Y. Campbell & Robert J. Shiller, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 58(3), pages 495-514.
    17. Peter Smith & Michael Wickens, 2002. "Asset Pricing with Observable Stochastic Discount Factors," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 397-446, July.
    18. Pagan, A.R. & Hall, A.D. & Martin, V., 1995. "Modelling the Term Structure," Papers 284, Australian National University - Department of Economics.
    19. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    20. Hansen, Peter Reinhard, 2003. "Structural changes in the cointegrated vector autoregressive model," Journal of Econometrics, Elsevier, vol. 114(2), pages 261-295, June.
    21. Ghysels, Eric & Santa-Clara, Pedro & Valkanov, Rossen, 2005. "There is a risk-return trade-off after all," Journal of Financial Economics, Elsevier, vol. 76(3), pages 509-548, June.
    22. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    23. Refet S. Gürkaynak & Jonathan H. Wright, 2012. "Macroeconomics and the Term Structure," Journal of Economic Literature, American Economic Association, vol. 50(2), pages 331-367, June.
    24. Jurgen Wolters, 1998. "Cointegration and German bond yields," Applied Economics Letters, Taylor & Francis Journals, vol. 5(8), pages 497-502.
    25. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 5, pages 129-164, World Scientific Publishing Co. Pte. Ltd..
    26. Jones, Charles M. & Lamont, Owen & Lumsdaine, Robin L., 1998. "Macroeconomic news and bond market volatility," Journal of Financial Economics, Elsevier, vol. 47(3), pages 315-337, March.
    27. Zivot, Eric & Andrews, Donald W K, 2002. "Further Evidence on the Great Crash, the Oil-Price Shock, and the Unit-Root Hypothesis," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 25-44, January.
    28. Tzavalis, Elias & Wickens, M. R., 1995. "The persistence in volatility of the US term premium 1970-1986," Economics Letters, Elsevier, vol. 49(4), pages 381-389, October.
    29. Neil R. Ericsson & James G. MacKinnon, 2002. "Distributions of error correction tests for cointegration," Econometrics Journal, Royal Economic Society, vol. 5(2), pages 285-318, June.
    30. Shiller, Robert J. & Huston McCulloch, J., 1990. "The term structure of interest rates," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 13, pages 627-722, Elsevier.
    31. Caporale, Barbara & Caporale, Tony, 2008. "Political risk and the expectations hypothesis," Economics Letters, Elsevier, vol. 100(2), pages 178-180, August.
    32. Kim, Woocheol & Linton, Oliver, 2011. "Estimation Of A Semiparametric Igarch(1,1) Model," Econometric Theory, Cambridge University Press, vol. 27(3), pages 639-661, June.
    33. Seo, Byeongseon, 2007. "Asymptotic distribution of the cointegrating vector estimator in error correction models with conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 137(1), pages 68-111, March.
    34. Carstensen, Kai, 2003. "Nonstationary term premia and cointegration of the term structure," Economics Letters, Elsevier, vol. 80(3), pages 409-413, September.
    35. Peter Kugler, 1988. "An Empirical Note on the Term Structure and Interest Rate Stabilization Policies," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 103(4), pages 789-792.
    36. Fountas, Stilianos & Karanasos, Menelaos, 2007. "Inflation, output growth, and nominal and real uncertainty: Empirical evidence for the G7," Journal of International Money and Finance, Elsevier, vol. 26(2), pages 229-250, March.
    37. Bremnes, Helge & Gjerde, Oystein & Soettem, Frode, 2001. " Linkages among Interest Rates in the United States, Germany and Norway," Scandinavian Journal of Economics, Wiley Blackwell, vol. 103(1), pages 127-145, March.
    38. Stilianos Fountas & Menelaos Karanasos & Alfonso Mendoza, 2004. "Output Variability and Economic Growth: the Japanese Case," Bulletin of Economic Research, Wiley Blackwell, vol. 56(4), pages 353-363, October.
    39. Lamoureux, Christopher G & Lastrapes, William D, 1990. "Persistence in Variance, Structural Change, and the GARCH Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(2), pages 225-234, April.
    40. John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, vol. 95(1), pages 138-160, March.
    41. Lumsdaine, Robin L, 1995. "Finite-Sample Properties of the Maximum Likelihood Estimator in GARCH(1,1) and IGARCH(1,1) Models: A Monte Carlo Investigation," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(1), pages 1-10, January.
    42. Evans, Martin D. D. & Lewis, Karen K., 1994. "Do stationary risk premia explain it all?: Evidence from the term structure," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 285-318, April.
    43. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, vol. 55(2), pages 391-407, March.
    44. Lundblad, Christian, 2007. "The risk return tradeoff in the long run: 1836-2003," Journal of Financial Economics, Elsevier, vol. 85(1), pages 123-150, July.
    45. Alain Hecq, 1996. "IGARCH effect on autoregressive lag length selection and causality tests," Applied Economics Letters, Taylor & Francis Journals, vol. 3(5), pages 317-323.
    46. Seo, Byeongseon, 1999. "Distribution theory for unit root tests with conditional heteroskedasticity1," Journal of Econometrics, Elsevier, vol. 91(1), pages 113-144, July.
    47. Bali, Turan G. & Engle, Robert F., 2010. "The intertemporal capital asset pricing model with dynamic conditional correlations," Journal of Monetary Economics, Elsevier, vol. 57(4), pages 377-390, May.
    48. Mark Rubinstein, 1976. "The Valuation of Uncertain Income Streams and the Pricing of Options," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 407-425, Autumn.
    49. Stock, James H, 1987. "Asymptotic Properties of Least Squares Estimators of Cointegrating Vectors," Econometrica, Econometric Society, vol. 55(5), pages 1035-1056, September.
    50. 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 347-366, July.
    51. Busch, Thomas, 2005. "A robust LR test for the GARCH model," Economics Letters, Elsevier, vol. 88(3), pages 358-364, September.
    52. Engsted, Tom & Tanggaard, Carsten, 1994. "Cointegration and the US term structure," Journal of Banking & Finance, Elsevier, vol. 18(1), pages 167-181, January.
    53. Kevin B. Grier & Mark J. Perry, 2000. "The effects of real and nominal uncertainty on inflation and output growth: some garch-m evidence," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(1), pages 45-58.
    54. 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 116-126, February.
    55. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Pagan, Adrian, 1996. "The econometrics of financial markets," Journal of Empirical Finance, Elsevier, vol. 3(1), pages 15-102, May.
    2. Kozicki, Sharon & Tinsley, P. A., 2001. "Shifting endpoints in the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 613-652, June.
    3. Guidolin, Massimo & Thornton, Daniel L., 2018. "Predictions of short-term rates and the expectations hypothesis," International Journal of Forecasting, Elsevier, vol. 34(4), pages 636-664.
    4. Olan Henry, 1999. "The volatility of US term structure term premia 1952 - 1991," Applied Financial Economics, Taylor & Francis Journals, vol. 9(3), pages 263-271.
    5. Noor Ghazali & Soo-Wah Low, 2002. "The expectation hypothesis in emerging financial markets: the case of Malaysia," Applied Economics, Taylor & Francis Journals, vol. 34(9), pages 1147-1156.
    6. Cuthbertson, Keith & Hayes, Simon & Nitzsche, Dirk, 2000. "Are German money market rates well behaved?," Journal of Economic Dynamics and Control, Elsevier, vol. 24(3), pages 347-360, March.
    7. Sharon Kozicki & Peter A. Tinsley, "undated". "Moving Endpoints in Macrofinance," Computing in Economics and Finance 1996 _058, Society for Computational Economics.
    8. Hiona Balfoussia & Mike Wickens, 2007. "Macroeconomic Sources of Risk in the Term Structure," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(1), pages 205-236, February.
    9. LeBaron, Blake, 2003. "Non-Linear Time Series Models in Empirical Finance,: Philip Hans Franses and Dick van Dijk, Cambridge University Press, Cambridge, 2000, 296 pp., Paperback, ISBN 0-521-77965-0, $33, [UK pound]22.95, [," International Journal of Forecasting, Elsevier, vol. 19(4), pages 751-752.
    10. Franses,Philip Hans & Dijk,Dick van, 2000. "Non-Linear Time Series Models in Empirical Finance," Cambridge Books, Cambridge University Press, number 9780521779654, January.
    11. Engsted, Tom, 2002. "Measures of Fit for Rational Expectations Models," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 301-355, July.
    12. Jondeau, E. & Sedillot, F., 1998. "La prevision des taux longs français et allemands a partir d'un modele a anticipations rationnelles," Working papers 55, Banque de France.
    13. Panagiotis T. Konstantinou, 2005. "The Expectations Hypothesis of the Term Structure : A Look at the Polish Interbank Market," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 41(3), pages 70-91, May.
    14. Diebold, Francis X. & Li, Canlin, 2006. "Forecasting the term structure of government bond yields," Journal of Econometrics, Elsevier, vol. 130(2), pages 337-364, February.
    15. Jondeau, E. & Ricart, R., 1996. "The Expectation Theory: Tests on French, German, and American Euro-Rates," Working papers 35, Banque de France.
    16. Peter Smith & Michael Wickens, 2002. "Asset Pricing with Observable Stochastic Discount Factors," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 397-446, July.
    17. Zeno Rotondi, 2006. "The Macroeconomy and the Yield Curve: A Review of the Literature with Some New Evidence," Giornale degli Economisti, GDE (Giornale degli Economisti e Annali di Economia), Bocconi University, vol. 65(2), pages 193-224, November.
    18. Tim Bollerslev & Ray Y. Chou & Narayanan Jayaraman & Kenneth F. Kroner - L, 1991. "es modéles ARCH en finance : un point sur la théorie et les résultats empiriques," Annals of Economics and Statistics, GENES, issue 24, pages 1-59.
    19. Committee, Nobel Prize, 2003. "Time-series Econometrics: Cointegration and Autoregressive Conditional Heteroskedasticity," Nobel Prize in Economics documents 2003-1, Nobel Prize Committee.
    20. T. J. Brailsford & K. Maheswaran, 1998. "The Dynamics of the Australian Short†Term Interest Rate," Australian Journal of Management, Australian School of Business, vol. 23(2), pages 213-234, December.

    More about this item

    Keywords

    Expectations Hypothesis; Holding Premium; Persistence; Cointegration; GARCH;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bay:rdwiwi:15152. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Gernot Deinzer (email available below). General contact details of provider: https://edirc.repec.org/data/wfregde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.