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Time Variation in Term Premia: International Evidence

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  • Jongen, Ron
  • Verschoor, Willem F C
  • Wolff, Christian C

Abstract

This paper examines the validity of the expectations hypothesis of the term structure of interest rates by means of a previously unexploited dataset of market expectations that covers a broad range of EMS versus non-EMS foreign currency deposits. Although we find strong evidence in favour of rejecting the ‘pure’ version of the expectations hypothesis, we still cannot reject the hypothesis that the forward rate is a biased estimate of future interest rate levels. Nevertheless, we find some evidence that the behaviour of market participants, when making predictions about the future level of interest rates, is not entirely in line with what rational behaviour would suggest. We also find that there is strong evidence of time-variation in the term structure of interest rates. Furthermore, while this variation in term premia can be very well explained by low-order variations of the ARMA class models, there is sufficient evidence that the conditional heteroskedasticity of term premia plays an important role in explaining the time-variation. Finally, no significant difference is found between the behaviour of EMS interest rate deposits and non-EMS deposits.

Suggested Citation

  • Jongen, Ron & Verschoor, Willem F C & Wolff, Christian C, 2005. "Time Variation in Term Premia: International Evidence," CEPR Discussion Papers 4959, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4959
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    References listed on IDEAS

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    Cited by:

    1. Giuseppe Ferrero & Andrea Nobili, 2009. "Futures Contract Rates as Monetary Policy Forecasts," International Journal of Central Banking, International Journal of Central Banking, vol. 5(2), pages 109-145, June.
    2. Bacchetta, Philippe & Mertens, Elmar & van Wincoop, Eric, 2009. "Predictability in financial markets: What do survey expectations tell us?," Journal of International Money and Finance, Elsevier, vol. 28(3), pages 406-426, April.
    3. Giuseppe Ferrero & Andrea Nobili, 2008. "Short-term interest rate futures as monetary policy forecasts," Temi di discussione (Economic working papers) 681, Bank of Italy, Economic Research and International Relations Area.
    4. Valente, Giorgio, 2009. "International interest rates and US monetary policy announcements: Evidence from Hong Kong and Singapore," Journal of International Money and Finance, Elsevier, vol. 28(6), pages 920-940, October.
    5. Smant, David / D.J.C., 2010. "Direct tests of the expectations theory of the term structure: Survey expectations, the term premium and coefficient biases," MPRA Paper 19815, University Library of Munich, Germany.
    6. Jongen, Ron & Verschoor, Willem F.C., 2008. "Further evidence on the rationality of interest rate expectations," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 18(5), pages 438-448, December.

    More about this item

    Keywords

    EMS; expectations hypothesis; interest rate expectations; rationality; survey data; term structure; time-varying term premia;

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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