New Evidence Concerning The Expectations Theory For The Short End Of The Maturity Spectrum

This paper re‐examines the evidence rejecting the expectations theory of the term structure. Weekly, monthly, and quarterly data on three‐ and six‐month interest rates are employed for five subperiods—1910–1914, 1919–1933, 1934–1959, 1959–1978, and 1979–1989. Econometric techniques are used to correct standard errors for overlapping data and for heteroscedasticity. Findings indicate that the weekly and monthly data are consistent with a weak form of the expectations hypothesis in which the yield curve has substantial predictive power for short rates for each subperiod except 1934–1959 and 1979–1989. Results for the period before the founding of the Federal Reserve indicate that a strong version of the expectations hypothesis cannot be rejected in which the joint hypothesis of rational expectations and expectations theory is hypothesized. The use of cointegration tests and an error‐correction model framework to determine whether short and long rates have a common stochastic trend indicates that long and short rates are cointegrated.