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The expectation hypothesis of the term structure of very short-term rates: statistical tests and economic value

Author

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  • Pasquale Della Corte
  • Lucio Sarno
  • Daniel L. Thornton

Abstract

This paper re-examines the validity of the Expectation Hypothesis (EH) of the term structure of US repo rates ranging in maturity from overnight to three months. We extend the work of Longstaff (2000a) in two directions: (i) we implement statistical tests designed to increase test power in this context; (ii) more importantly, we assess the economic value of departures from the EH based on criteria of profitability and economic significance in the context of a simple trading strategy. The EH is rejected throughout the term structure examined on the basis of the statistical tests. However, the results of our economic analysis are favorable to the EH, suggesting that the statistical rejections of the EH in the repo market are economically insignificant.

Suggested Citation

  • Pasquale Della Corte & Lucio Sarno & Daniel L. Thornton, 2007. "The expectation hypothesis of the term structure of very short-term rates: statistical tests and economic value," Working Papers 2006-061, Federal Reserve Bank of St. Louis.
    • Handle: RePEc:fip:fedlwp:2006-061
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    More about this item

    Keywords

    Interest rates;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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