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On Expectations, Term Premiums and the Volatility of Long-Term Interest Rates

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  • James E. Pesando

Abstract

The paper first identifies how large must be the range in which ex ante yields on long-relative to short-term bonds vary if term premiums -- are to account for a significant fraction of the variance of the holding- period yields on long-term bonds. This paper then extends Shiller's bound to the case of a time-varying term premium and readily identifies the variance in the term premium necessary to salvage the efficient markets model if the variance of these holding-period yields exceeds the bound implied by the rational expectations model. The role of transactions costs is noted and the possibility explored that evidence of excess volatility need not imply the existence of unexploited profit opportunities under the rational expectations model.

Suggested Citation

  • James E. Pesando, 1980. "On Expectations, Term Premiums and the Volatility of Long-Term Interest Rates," NBER Working Papers 0595, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0595 Note: ME
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    References listed on IDEAS

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    1. Franco Modigliani & Richard Sutch, 1967. "Debt Management and the Term Structure of Interest Rates: An Empirical Analysis of Recent Experience," Journal of Political Economy, University of Chicago Press, vol. 75, pages 569-569.
    2. Masson, Paul R, 1978. "Structural Models of the Demand for Bonds and the Term Structure of Interest Rates," Economica, London School of Economics and Political Science, vol. 45(180), pages 363-377, November.
    3. Reuben A. Kessel, 1965. "The Cyclical Behavior of the Term Structure of Interest Rates," NBER Books, National Bureau of Economic Research, Inc, number kess65-1, January.
    4. Modigliani, Franco & Shiller, Robert J, 1973. "Inflation, Rational Expectations and the Term Structure of Interest Rates," Economica, London School of Economics and Political Science, vol. 40(157), pages 12-43, February.
    5. McCallum, John S, 1975. "The Expected Holding Period Return, Uncertainty and the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 30(2), pages 307-323, May.
    6. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
    7. Singleton, Kenneth J, 1980. "Expectations Models of the Term Structure and Implied Variance Bounds," Journal of Political Economy, University of Chicago Press, vol. 88(6), pages 1159-1176, December.
    8. McCulloch, J Huston, 1975. "An Estimate of the Liquidity Premium," Journal of Political Economy, University of Chicago Press, vol. 83(1), pages 95-119, February.
    9. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
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    Cited by:

    1. Charles Freedman, 1981. "Some Theoretical Aspects of Base Control," NBER Working Papers 0650, National Bureau of Economic Research, Inc.
    2. Shiller, Robert J, 1981. "The Use of Volatility Measures in Assessing Market Efficiency," Journal of Finance, American Finance Association, vol. 36(2), pages 291-304, May.

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