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Around and Around: The Expectations Hypothesis

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  • Mark Fisher
  • Christian Gilles

Abstract

We show how to construct arbitrage-free models of he term structure of interest rates in which various expectations hypotheses can hold. McCulloch (1993) provided a Gaussian non-Markovian example of the unbiased expectations hypothesis (U--EH), thereby contradicting the assertion by Cox, Ingersoll, and Ross (CIR, 1981) that only the so-called local expectations hypothesis could hold. We generalize that example in three ways: (i) We characterize the U--EH in terms of forward rates; (ii) we extend this characterization to a class of expectations hypotheses that includes all of those considered by CIR; and (iii) we construct stationary Markovian and non-Gaussian economies. The building block is a maturity-dependent vector that travels around a circle at a constant speed as maturity increases.

Suggested Citation

  • Mark Fisher & Christian Gilles, "undated". "Around and Around: The Expectations Hypothesis," Finance and Economics Discussion Series 1996-17, Board of Governors of the Federal Reserve System (U.S.), revised 04 Dec 2019.
    • Handle: RePEc:fip:fedgfe:1996-17
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    File URL: http://www.federalreserve.gov/pubs/feds/1996/199617/199617pap.pdf
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    References listed on IDEAS

    as
    1. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1981. "A Re-examination of Traditional Hypotheses about the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 36(4), pages 769-799, September.
    2. Campbell, John Y, 1986. "A Defense of Traditional Hypotheses about the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 41(1), pages 183-193, March.
    3. Woodward, Susan E, 1983. "The Liquidity Premium and the Solidity Premium," American Economic Review, American Economic Association, vol. 73(3), pages 348-361, June.
    4. David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305, World Scientific Publishing Co. Pte. Ltd..
    5. 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.
    6. McCulloch, J Huston, 1993. "A Reexamination of Traditional Hypotheses about the Term Structure: A Comment," Journal of Finance, American Finance Association, vol. 48(2), pages 779-789, June.
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