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A Flexible Non Linear Model to Test the Expectation Hypothesis of Interest Rates

Author

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  • Jean-michel Sahut

    () (Amiens School of Management and CEREGE EA 1722 University of Poitiers)

Abstract

Conventional approaches to examining the expectation hypothesis of interest rates assume a parametric linear specification among variables. In contrast, this paper tests the hypothesis using a flexible nonlinear inference approach proposed by Hamilton (2001). We examine the impact of the nonlinearity of interest rates to explain the variability of risk premia on market rates. It is assumed that the term structure of interest rates can be identified by two factors, the risk-free rate and its volatility. The results of the linearity test against nonlinear alternatives suggest that there is clear evidence of nonlinearity. Our empirical study shows that correctly accounting for the nonlinearity of the term structure of interest rates may explain the variability of risk premia and the specific characteristics of interest rate dynamics on the U.S. market.

Suggested Citation

  • Jean-michel Sahut, 2010. "A Flexible Non Linear Model to Test the Expectation Hypothesis of Interest Rates," Economics Bulletin, AccessEcon, vol. 30(3), pages 2297-2311.
  • Handle: RePEc:ebl:ecbull:eb-10-00261
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    References listed on IDEAS

    as
    1. Hamilton, James D., 1988. "Rational-expectations econometric analysis of changes in regime : An investigation of the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 385-423.
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    3. Bekaert, Geert & Hodrick, Robert J. & Marshall, David A., 1997. "On biases in tests of the expectations hypothesis of the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 44(3), pages 309-348, June.
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    More about this item

    Keywords

    Term structure of interest rates; Non linearity; expectation hypothesis; flexible models.;

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment

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