Expectations Hypothesis Of Term Structure Research Articles

The impact of the term spread in US monetary policy from 1870 to 2013

In this paper, we apply a novel econometric approach joint with an exhaustive revision of the main events in the history of US monetary policy in order to check the effectiveness of monetary policy focused on interest rates. Unlike the traditional cointegration approach, this new methodology allows us to break with the rigidity of traditional approaches in favour of letting the series be cointegrated, and the spread is able to follow a long-memory process; i.e., it does not necessarily need to be I(0) and also rejects the assumption that interest rates could follow the dichotomy I(0)/I(1). To the best of our knowledge, this is one of the first applications of the Fractionally Cointegrated Vector Autoregressive (FCVAR) model (Johansen and Nielsen (2012) and Nielsen and Popiel (2016)). Aiming to achieve this goal, we use two databases, i.e., the Jordà-Schularick-Taylor Macrohistory Database and Shiller’s database. Our results cannot reject the Expectations Hypothesis of Term Structure in this time period, and more importantly, we also find that the long-term rate drives the long-run relationship, contributing to the total proportion to the common trend; the persistence of the spread shows us effective control power over interest rates by the Fed.

The role of Eonia in the dynamics of short-term interbank rates

To signal monetary policies and market expectations, we apply a fractionally cointegrated vector autoregressive (FCVAR) model, aiming to analyse the expectations hypothesis of term structure (EHTS), persistence in the Euro OverNight Index Average (Eonia) spread and permanent-transitory decomposition using a novel approach. We use a monthly frequency sample for the 3- month Euribor rate and Eonia rate, covering the period from January 1999 to February 2019. The results obtained confirm the EHTS and show evidence of a high persistence of the spread, which means that shocks may impede effectiveness in monetary policy and that the European Central Bank (ECB) loses control over interest rates. Additionally, according to permanent-transitory decomposition, we determine that the Eonia rate has a permanent component and thus dominates the common trend in the cointegration system. In sum, if the ECB wants to keep the interbank market interest rates under control, it must contemplate the evolution of the Eonia rate.

Testing the Expectations Hypothesis of Interest Rate Term Structure in Kuwait

This paper investigates the validity of the expectations hypothesis for the term structure of interest rates in the context of the deposit interest rates in Kuwait. The data set covers average inter local bank interest rates on deposits of Kuwaiti Dinar (KD) with maturity of one, three and six months from the period June 1994 to August 2008. We utilize Johansen procedures to examine the relationship between spot and forward rates. Our findings show that the spot and forward rates are cointegrated for all cases, the one month interest rates, the three month interest rates as well as the six month interest rates. The explanation of this relationship indicates that the expectations hypothesis of the term structure of interest rates is accepted for the case of Kuwait.

Term Structure of Interest Rates and Expected Consumption Volatility: Empirical Test of Term Premiums

We test two forms of consumption-based asset pricing model on American bond market data. The first is the standard C-CAPM, the other one is derived from Abel (1999) who refers to an external habit. The term premium embedded in the term structure of interest rate is linked with the conditional variance of consumption growth and is variable through time. Our empirical test confirms that hypothesis. When modeling consumption using an AR-GARCH process, the ex ante out-of-sample value of the conditional variance is shown superior to other conditional measures. Considering both univariate and multivariate frameworks, variable term premiums are positively linked to variable consumption growth expectations. It supports the expectations hypothesis of term structure and the standard consumption-based asset pricing model. However, a significant constant appears in the empirical test which is not present in the standard consumption models, but can be related to the subjective discount factor of the representative agent. It leads to question the commonly assumed hypothesis of a constant subjective time preference and suggests a decreasing term structure of the agent psychological price of time.

The information content of the term structure of interest rates

This paper presents the results of an alternative test of the rational expectations theory of the term structure of interest rates. Other researchers have also examined the validity of the expectations hypothesis of term structure. While there is more often rejection of the expectations hypothesis, no other theory (data-consistent with the entire yield curve) provides an empirically adequate explanation of this phenomenon. The study considers postwar US pure discount (zero coupons) bond yields with various maturities, from one month to 60 months. Based on the ex post formation of rational expectations, the expectations error is quantified and the level of truth of the expectations hypothesis tested, that is, the strength of the departure of the yield curve from the expectations theory. The results suggest that a significant amount of information available at no cost to market agents is not incorporated in forming people's expectations.

Expectations and Equilibrium in High-Grade Australian Bond Markets

This paper examines the equilibrium implications of the Expectations Hypothesis of term structure to different maturities of high-grade Australian dollar denominated Eurobonds and Australian Government bonds (AGBs) using the Canonical Cointegrating Regression (CCR) technique developed by Econometrica 60 (1992) 119. Our findings provide evidence only for equilibrium relationships between each group of bonds based on credit class, but not between any of the subsets of AGBs and the Eurobonds. Furthermore, the error correction model supports theory with the most liquid, long-term 10-year AGB driving the AGB term structure, with short-term yields adjusting to movements in the long-run yields, though the opposite is true for Eurobonds. The lesson for markets is to simplify the risk management task. Managers are advised to treat portfolios of equivalent credit class separately for hedging and risk management.