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A defence of the expectations theory as a model of us long-term interest rates

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  • Gregory D. Sutton

Abstract

This paper re-examines the empirical content of the expectations theory of the term structure by employing the Campbell-Shiller (1987) methodology to study the behaviour of 10-year/three-month US government yield spreads. The methodology is implemented in two ways. First, theoretical spreads satisfying the expectations theory are constructed from in-sample forecasts of future changes in short rates generated from a small-scale VAR. Second, theoretical spreads are computed from out-of-sample forecasts of changes in short rates with the parameters of each VAR equation updated with a Bayesian procedure. When the procedure is restricted to give less weight to new data than would be the case with OLS estimation over an expanding sample, theoretical spreads computed from out-of-sample forecasts track actual spreads closely in pre-1979 data. This is also the case as from the start of 1984 if data from the 1979Q4-1982Q4 period of non-borrowed reserve targeting are given zero weight when estimating the parameters of the VAR.

Suggested Citation

  • Gregory D. Sutton, 2000. "A defence of the expectations theory as a model of us long-term interest rates," BIS Working Papers 85, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:85
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    References listed on IDEAS

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    1. Campbell, John Y & Shiller, Robert J, 1984. "A Simple Account of the Behavior of Long-Term Interest Rates," American Economic Review, American Economic Association, vol. 74(2), pages 44-48, May.
    2. Jeffrey C. Fuhrer, 1996. "Monetary Policy Shifts and Long-Term Interest Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 111(4), pages 1183-1209.
    3. Campbell, John Y & Shiller, Robert J, 1987. "Cointegration and Tests of Present Value Models," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 1062-1088, October.
    4. John Y. Campbell & Robert J. Shiller, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Oxford University Press, vol. 58(3), pages 495-514.
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    Cited by:

    1. Jennifer E. Roush, 2001. "Evidence uncovered: long-term interest rates, monetary policy, and the expectations theory," International Finance Discussion Papers 712, Board of Governors of the Federal Reserve System (U.S.).
    2. Gerlach, Stefan, 2003. "Interpreting the term structure of interbank rates in Hong Kong," Pacific-Basin Finance Journal, Elsevier, vol. 11(5), pages 593-609, November.
    3. Abad, Pilar & Novales, Alfonso, 2005. "An error correction factor model of term structure slopes in international swap markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 15(3), pages 229-254, July.
    4. Nicolas Rautureau, 2004. "Modèles à changement de régime et test de la théorie des anticipations rationnelles de la structure par terme des taux dintérêt en France," Économie et Prévision, Programme National Persée, vol. 163(2), pages 117-129.

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