New evidence on the expectations theory of the term structure of Australian Commonwealth Government Treasury yields

Abstract

This paper seeks new evidence on the expectations theory of the term structure of Australian Commonwealth Government Treasury yields. The paper contributes to the existing literature in two ways. First, the traditional regression tests of the expectations hypothesis are respecified to allow for coupon payments on one- and two-year securities. The paper shows that failing to respecify the traditional estimating equations for the coupon effect biases the results. The regression tests provide evidence for a time-varying term premium in the term structure for one- and two-year yields and, also, for short-term (13- and 26-week) yields. Second, we test for cointegration in short and long rates using two approaches: the approach in Engle and Granger (1987) using ADF tests and the approach developed by Hansen (1992) in which tests of parameter stability in the presence of integrated processes can be interpreted as tests of cointegration. We find conflicting evidence that long and short rates are cointegrated and ...