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On expectations, term premiums and the volatility of long-term interest rates

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  • Pesando, James E.

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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Suggested Citation

  • Pesando, James E., 1983. "On expectations, term premiums and the volatility of long-term interest rates," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 467-474, September.
    • Handle: RePEc:eee:moneco:v:12:y:1983:i:3:p:467-474
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    Cited by:

    1. Charles Freedman, 1981. "Some Theoretical Aspects of Base Control," NBER Working Papers 0650, National Bureau of Economic Research, Inc.
    2. Shiller, Robert J, 1981. "The Use of Volatility Measures in Assessing Market Efficiency," Journal of Finance, American Finance Association, vol. 36(2), pages 291-304, May.

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