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Surprises, sentiments, and the expectations hypothesis of the term structure of interest rates

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  • Cathy Yi-Hsuan Chen

    (Humboldt-Universität zu Berlin
    Chung Hua University)

  • Thomas C. Chiang

    (Drexel University)

Abstract

This study shows that time-varying coefficients in the term structure of interest rates equation are correlated with the time-varying term premiums (TVTP) and expectation error (EE). Consistent with Froot (J Finance 44:283–305, 1989), TVTP and EE are the main factors that cause variations in the expectations hypothesis. Once the TVTP and the EE are appropriately incorporated into the model, the GARCH-M evidence fades away. This study documents that investors’ sentiment and macroeconomic surprises are the main driving forces behind the TVTP and EE. Evidence of significant sentiment and its interacting with macroeconomic surprises shed some light on the bias due to behavioral variations.

Suggested Citation

  • Cathy Yi-Hsuan Chen & Thomas C. Chiang, 2017. "Surprises, sentiments, and the expectations hypothesis of the term structure of interest rates," Review of Quantitative Finance and Accounting, Springer, vol. 49(1), pages 1-28, July.
    • Handle: RePEc:kap:rqfnac:v:49:y:2017:i:1:d:10.1007_s11156-016-0584-y
    DOI: 10.1007/s11156-016-0584-y
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    Cited by:

    1. Dušan Staniek, 2018. "The Expectations Hypothesis in the Theory and Practice of Current Interest Rate Instruments [Hypotéza očekávání v teorii a praxi současných úrokových instrumentů]," Český finanční a účetní časopis, Prague University of Economics and Business, vol. 2018(2), pages 61-79.

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    More about this item

    Keywords

    Expectations hypothesis; Time-varying coefficient model; Sentiment; Expectation error; Term premium;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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