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The Rational Expectations Hypothesis of the Term Structure: reconciling the evidence

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  • Elias Tzavalis
  • Michael Wickens

Abstract

The main aim of this paper is to test the rational expectations hypothesis of the term structure (REHTS). Existing empirical studies of the REHTS provide inconsistent evidence. Tests based on the local expectations hypothesis (LEH) version of the REHTS tend to be far less supportive than those based on the return to maturity expectations hypothesis (RTMEH), especially when they concern the short-run implications of the hypothesis. This paper explains the differences between these alternative versions of the REHTS and estimates a number of models to try to explain the inconsistencies in previous results. Our conclusions are that the most probable cause of these differences is the failure to take account of the presence of a time-varying term premium. Once this is accounted for both short-run and long-run evidence is found to support the REHTS. Estimates of variance bounds of the term premium suggest that it may not vary sufficiently to be the sole explanation for the differences.

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Bibliographic Info

Paper provided by Department of Economics, University of York in its series Discussion Papers with number 95/33.

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Handle: RePEc:yor:yorken:95/33

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Postal: Department of Economics and Related Studies, University of York, York, YO10 5DD, United Kingdom
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Web page: http://www.york.ac.uk/economics/
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Cited by:
  1. Tzavalis, Elias & Wickens, M. R., 1996. "Forecasting inflation from the term structure," Journal of Empirical Finance, Elsevier, vol. 3(1), pages 103-122, May.
  2. Theis Lange, 2009. "First and second order non-linear cointegration models," CREATES Research Papers 2009-04, School of Economics and Management, University of Aarhus.

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