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On Expectations, Term Premiums and the Volatility of Long-Term Interest Rates

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  • James E. Pesando

Abstract

The paper first identifies how large must be the range in which ex ante yields on long-relative to short-term bonds vary if term premiums -- are to account for a significant fraction of the variance of the holding- period yields on long-term bonds. This paper then extends Shiller's bound to the case of a time-varying term premium and readily identifies the variance in the term premium necessary to salvage the efficient markets model if the variance of these holding-period yields exceeds the bound implied by the rational expectations model. The role of transactions costs is noted and the possibility explored that evidence of excess volatility need not imply the existence of unexploited profit opportunities under the rational expectations model.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0595.

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Date of creation: Dec 1980
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Publication status: published as Pesando, James E. "On Expectations, Term Premiums and the Volatility of Long-Term Interest Rates." Journal of Monetary Economics, Vol. 12, No. 3, (September 1983), pp. 467-74.
Handle: RePEc:nbr:nberwo:0595

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  1. McCulloch, J Huston, 1975. "An Estimate of the Liquidity Premium," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 83(1), pages 95-119, February.
  2. 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, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
  3. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 1(1), pages 19-46, January.
  4. Reuben A. Kessel, 1965. "The Cyclical Behavior of the Term Structure of Interest Rates," NBER Books, National Bureau of Economic Research, Inc, number kess65-1, July.
  5. McCallum, John S, 1975. "The Expected Holding Period Return, Uncertainty and the Term Structure of Interest Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 30(2), pages 307-23, May.
  6. Masson, Paul R, 1978. "Structural Models of the Demand for Bonds and the Term Structure of Interest Rates," Economica, London School of Economics and Political Science, London School of Economics and Political Science, vol. 45(180), pages 363-77, November.
  7. Modigliani, Franco & Shiller, Robert J, 1973. "Inflation, Rational Expectations and the Term Structure of Interest Rates," Economica, London School of Economics and Political Science, London School of Economics and Political Science, vol. 40(157), pages 12-43, February.
  8. Singleton, Kenneth J, 1980. "Expectations Models of the Term Structure and Implied Variance Bounds," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(6), pages 1159-76, December.
  9. Franco Modigliani & Richard Sutch, 1967. "Debt Management and the Term Structure of Interest Rates: An Empirical Analysis of Recent Experience," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 75, pages 569.
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Cited by:
  1. Shiller, Robert J, 1981. "The Use of Volatility Measures in Assessing Market Efficiency," Journal of Finance, American Finance Association, American Finance Association, vol. 36(2), pages 291-304, May.
  2. Charles Freedman, 1981. "Some Theoretical Aspects of Base Control," NBER Working Papers 0650, National Bureau of Economic Research, Inc.

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