The expectation hypothesis of the term structure of very short-term rates: statistical tests and economic value

Pasquale Della Corte, Lucio Sarno and Daniel Thornton

No 2006-061, Working Papers from Federal Reserve Bank of St. Louis

Abstract: This paper re-examines the validity of the Expectation Hypothesis (EH) of the term structure of US repo rates ranging in maturity from overnight to three months. We extend the work of Longstaff (2000a) in two directions: (i) we implement statistical tests designed to increase test power in this context; (ii) more importantly, we assess the economic value of departures from the EH based on criteria of profitability and economic significance in the context of a simple trading strategy. The EH is rejected throughout the term structure examined on the basis of the statistical tests. However, the results of our economic analysis are favorable to the EH, suggesting that the statistical rejections of the EH in the repo market are economically insignificant.

Keywords: Interest; rates (search for similar items in EconPapers)
Date: 2007
New Economics Papers: this item is included in nep-fmk and nep-mon
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Published in Journal of Financial Economics, July 2008, 89(1), pp. 158-74

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Related works:
Journal Article: The expectation hypothesis of the term structure of very short-term rates: Statistical tests and economic value (2008)
Working Paper: The Expectation Hypothesis of the Term Structure of Very Short-Term Rates: Statistical Tests and Economic Value (2007)
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DOI: 10.20955/wp.2006.061

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