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Financial Factors, Macroeconomic Information and the Expectations Theory of the Term Structure of Interest Rates

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  • Andrea Carriero
  • Carlo Favero
  • Iryna Kaminska

Abstract

In this paper we concentrate on the hypothesis that the empirical rejections of the Expectations Theory(ET) of the term structure of interest rates can be caused by improper modelling of expectations. Our starting point is an interesting anomaly found by Campbell-Shiller(1987), when by taking a VAR approach they abandon limited information approach to test the ET, in which realized returns are taken as a proxy for expected returns. We use financial factors and macroeconomic information to construct a test of the theory based on simulating investors’ effort to use the model in ‘real time’ to forecast future monetary policy rates. Our findings suggest that the importance of fluctuations of risk premia in explaining the deviation from the ET is reduced when some forecasting model for short-term rates is adopted and a proper evaluation of uncertainty associated to policy rates forecast is considered.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 253.

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Date of creation: 2004
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Handle: RePEc:igi:igierp:253

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