Explaining the failures of the term spread models of the rational expectations hypothesis of the term structure

E Tzavalis; M R Wickens

Explaining the failures of the term spread models of the rational expectations hypothesis of the term structure

Economics

Research output: Contribution to journal › Article › peer-review

Abstract

Contrary to the predictions of the rational expectations hypothesis of the term structure of interest rates, empirical evidence suggests that the term spread between long and short rates fails to forecast future movements of long-term rates although its forecasts of future short-term rates are in the correct direction. in this paper, we show that this puzzling behavior of the term spread alone can be explained by a time-varying term premium that is correlated with the term spread. Once this is accounted for, neither expression of the expectations hypothesis is against the predictions of the theory.

Original language	English
Pages (from-to)	364-380
Number of pages	17
Journal	Journal of Money Credit and Banking
Volume	29
Issue number	3
Publication status	Published - Aug 1997

Keywords

INTEREST-RATES
TRADITIONAL HYPOTHESES
COINTEGRATION ANALYSIS
ECONOMETRIC-ANALYSIS
UNIT-ROOT
MONOTONICITY
VOLATILITY
BEHAVIOR
VECTORS
PREMIUM

Cite this

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title = "Explaining the failures of the term spread models of the rational expectations hypothesis of the term structure",

abstract = "Contrary to the predictions of the rational expectations hypothesis of the term structure of interest rates, empirical evidence suggests that the term spread between long and short rates fails to forecast future movements of long-term rates although its forecasts of future short-term rates are in the correct direction. in this paper, we show that this puzzling behavior of the term spread alone can be explained by a time-varying term premium that is correlated with the term spread. Once this is accounted for, neither expression of the expectations hypothesis is against the predictions of the theory.",

keywords = "INTEREST-RATES, TRADITIONAL HYPOTHESES, COINTEGRATION ANALYSIS, ECONOMETRIC-ANALYSIS, UNIT-ROOT, MONOTONICITY, VOLATILITY, BEHAVIOR, VECTORS, PREMIUM",

author = "E Tzavalis and Wickens, {M R}",

year = "1997",

month = aug,

language = "English",

volume = "29",

pages = "364--380",

journal = "Journal of Money Credit and Banking",

issn = "0022-2879",

publisher = "Wiley-Blackwell",

number = "3",

}

TY - JOUR

T1 - Explaining the failures of the term spread models of the rational expectations hypothesis of the term structure

AU - Tzavalis, E

AU - Wickens, M R

PY - 1997/8

Y1 - 1997/8

N2 - Contrary to the predictions of the rational expectations hypothesis of the term structure of interest rates, empirical evidence suggests that the term spread between long and short rates fails to forecast future movements of long-term rates although its forecasts of future short-term rates are in the correct direction. in this paper, we show that this puzzling behavior of the term spread alone can be explained by a time-varying term premium that is correlated with the term spread. Once this is accounted for, neither expression of the expectations hypothesis is against the predictions of the theory.

AB - Contrary to the predictions of the rational expectations hypothesis of the term structure of interest rates, empirical evidence suggests that the term spread between long and short rates fails to forecast future movements of long-term rates although its forecasts of future short-term rates are in the correct direction. in this paper, we show that this puzzling behavior of the term spread alone can be explained by a time-varying term premium that is correlated with the term spread. Once this is accounted for, neither expression of the expectations hypothesis is against the predictions of the theory.

KW - INTEREST-RATES

KW - TRADITIONAL HYPOTHESES

KW - COINTEGRATION ANALYSIS

KW - ECONOMETRIC-ANALYSIS

KW - UNIT-ROOT

KW - MONOTONICITY

KW - VOLATILITY

KW - BEHAVIOR

KW - VECTORS

KW - PREMIUM

M3 - Article

SN - 0022-2879

VL - 29

SP - 364

EP - 380

JO - Journal of Money Credit and Banking

JF - Journal of Money Credit and Banking

IS - 3

ER -