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The Expectation Hypothesis of the Term Structure of Very Short-Term Rates: Statistical Tests and Economic Value

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Author Info
Della Corte, Pasquale
Sarno, Lucio
Thornton, Daniel L

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Abstract

This paper re-examines the validity of the Expectation Hypothesis (EH) of the term structure of US repo rates ranging in maturity from overnight to three months. We extend the work of Longstaff (2000a) in two directions: (i) we implement statistical tests designed to increase test power in this context; (ii) more importantly, we assess the economic value of departures from the EH based on criteria of profitability and economic significance in the context of a simple trading strategy. The EH is rejected throughout the term structure examined on the basis of the statistical tests. However, the results of our economic analysis are favorable to the EH, suggesting that the statistical rejections of the EH in the repo market are economically insignificant.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6445.

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Date of creation: Sep 2007
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Handle: RePEc:cpr:ceprdp:6445

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Related research
Keywords: economic value; expectation hypothesis; term structure of interest rates; vector autoregression;

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Find related papers by JEL classification:
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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References listed on IDEAS
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Cited by:
(explanations, 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. Rime, Dagfinn & Sarno, Lucio & Sojli, Elvira, 2009. "Exchange Rate Forecasting, Order Flow and Macroeconomic Information," CEPR Discussion Papers 7225, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. Daniel L. Thornton, 2009. "How did we get to inflation targeting and where do we go now? a perspective from the U.S. experience," Working Papers 2009-038, Federal Reserve Bank of St. Louis. [Downloadable!]
  3. Daniel L. Thornton, 2008. "Monetary policy: why money matters and interest rates don't," Working Papers 2008-011, Federal Reserve Bank of St. Louis. [Downloadable!]
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