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Yield Spreads and Interest Rate Movements: A Bird's Eye View

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Listed author(s):
  • John Y. Campbell
  • Robert J. Shiller

Abstract

The expectations theory of the term structure implies that the spread between a longer-term interest rate and a shorter-term interest rate forecasts two subsequent interest rate changes: the change in yield of the longer-term bond over the life of the shorter-term bond, and a weighted average of the changes in shorter-term rates over the life of the longer-term bond. For postwar U.S. data from Mcculloch [1987] and just about any combination of maturities between one month and ten years we find that the former relation is not borne out by the data, the latter roughly is. When the yield spread is high the yield on the longer-term bond tends to fall, contrary to the expectations theory; at the same time, the shorter-term interest rate tends to rise, just as the expectations theory requires. We discuss several possible interpretations of these findings. We argue that they are consistent with a model in which the spread is a multiple of the value implied by the expectations theory. This model could be generated by time-varying risk premia which are correlated with expected increases in short-term interest rates, or by a failure of rational expectations in our sample period.

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File URL: http://www.nber.org/papers/w3153.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3153.

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Date of creation: Oct 1989
Publication status: published as Review of Economic Studies, Vol. 58, pp. 495-514, (1991).
Handle: RePEc:nbr:nberwo:3153
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  1. Mishkin, Frederic S, 1988. "The Information in the Term Structure: Some Further Results," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 3(4), pages 307-314, October-D.
  2. N. Gregory Mankiw & Lawrence H. Summers, 1984. "Do Long-Term Interest Rates Overreact to Short-Term Interest Rates?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(1), pages 223-248.
  3. Froot, Kenneth A, 1989. " New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 44(2), pages 283-305, June.
  4. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1981. "A Re-examination of Traditional Hypotheses about the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 36(4), pages 769-799, September.
  5. Campbell, John Y, 1986. " A Defense of Traditional Hypotheses about the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 41(1), pages 183-193, March.
  6. Mishkin, Frederic S., 1990. "What does the term structure tell us about future inflation?," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 77-95, January.
  7. Frederic S. Mishkin, 1990. "The Information in the Longer Maturity Term Structure about Future Inflation," The Quarterly Journal of Economics, Oxford University Press, vol. 105(3), pages 815-828.
  8. 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.
  9. Gregory Mankiw, N. & Shapiro, Matthew D., 1986. "Do we reject too often? : Small sample properties of tests of rational expectations models," Economics Letters, Elsevier, vol. 20(2), pages 139-145.
  10. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
  11. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(1), pages 173-224.
  12. 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.
  13. 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.
  14. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
  15. Matthew Richardson & James H. Stock, 1990. "Drawing Inferences From Statistics Based on Multi-Year Asset Returns," NBER Working Papers 3335, National Bureau of Economic Research, Inc.
  16. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-692, September.
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