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Predictions of short-term rates and the expectations hypothesis of the term structure of interest rates

  • Daniel L. Thornton

Despite its important role in macroeconomics and finance, the expectations hypothesis (EH) of the term structure of interest rates has received little empirical support. While the EH*s poor performance has been attributed to a variety of sources, none appear to account for the EH*s poor performance. Recent evidence (Diebold and Li, 2003; Duffee, 2002; and Carriero, et al., 2003) suggests the possibility that the EH*s poor performance may be due to market participants* relative inability to forecast the short-term rate. This possibility is investigate by comparing h-month ahead forecasts for the 1-month Treasury yield implied by the EH with the forecasts from both random-walk model and a three factor model of the term structure.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2004-010.

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Date of creation: 2005
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Handle: RePEc:fip:fedlwp:2004-010
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