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New evidence of the expectation hypothesis of interest rates: a flexible nonlinear approach

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  • Medhi Mili
  • Jean-Michel Sahut
  • Fredéric Teulon

Abstract

Conventional approaches to examining the Expectation Hypothesis (EH) assume a parametric linear specification among variables. In contrast, this article 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 application 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 US market.

Suggested Citation

  • Medhi Mili & Jean-Michel Sahut & Fredéric Teulon, 2012. "New evidence of the expectation hypothesis of interest rates: a flexible nonlinear approach," Applied Financial Economics, Taylor & Francis Journals, vol. 22(2), pages 165-176, January.
  • Handle: RePEc:taf:apfiec:v:22:y:2012:i:2:p:165-176
    DOI: 10.1080/09603107.2011.607127
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    File URL: http://hdl.handle.net/10.1080/09603107.2011.607127
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    References listed on IDEAS

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    1. Mishkin, Frederic S., 1990. "What does the term structure tell us about future inflation?," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 77-95, January.
    2. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Araç, Ayşen & Yalta, A. Yasemin, 2015. "Testing the expectations hypothesis for the Eurozone: A nonlinear cointegration analysis," Finance Research Letters, Elsevier, vol. 15(C), pages 41-48.
    2. Ayşen ARAÇ, 2015. "Nonlinear Dynamics in Term Structure of Interest Rates: Evidence from the Euro Area," Sosyoekonomi Journal, Sosyoekonomi Society, issue 23(26).

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