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Peso problem explanations for term structure anomalies

  • Bekaert, Geert
  • Hodrick, Robert J.
  • Marshall, David A.

We examine the empirical evidence on the expectations hypothesis of the term structure of interest rates in the United States, the United Kingdom, and Germany using the Campbell-Shiller (1991) regressions and a vector-autoregressive" methodology. We argue that anomalies in the U.S. term structure, documented by Campbell and Shiller (1991), may be due to a generalized peso problem in which a high-interest rate regime occurred less frequently in the sample of U.S. data than was rationally anticipated. We formalize this idea as a regime-switching model of short-term interest rates estimated with data" from seven countries. Technically, this model extends recent research on regime-switching models with state-dependent transitions to a cross-sectional setting. Use of the small sample distributions generated by the regime-switching model for inference considerably weakens the evidence against the expectations hypothesis, but it remains somewhat implausible that our data-generating process produced the U.S. data. However, a model that combines moderate time-variation in term premiums with peso-problem effects is largely consistent with term structure data from the U.S., U.K., and Germany.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 48 (2001)
Issue (Month): 2 (October)
Pages: 241-270

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Handle: RePEc:eee:moneco:v:48:y:2001:i:2:p:241-270
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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