Where (and by How Much) Does a Theory Break Down? With an Application to the Expectation Hypothesis

Karim M. Abadir and Christina Atanasova

A chapter in Essays in Honor of M. Hashem Pesaran: Panel Modeling, Micro Applications, and Econometric Methodology, 2022, vol. 43B, pp 255-267 from Emerald Group Publishing Limited

Abstract: The authors provide new evidence in favor of the expectation hypothesis (EH) as a long-run theory of the term structure of interest rates. Using nonparametric techniques first, the authors show that the results of conventional tests that reject EH are strongly affected by the presence of extreme observations – only a handful in the case of longer maturities. The authors then provide a new general methodology that determines the number of outliers causinganytheory to fail, and their approach quantifies the extent of this failure.

Keywords: Expectation hypothesis; term structure of interest rates; Peso problem; outliers; nonparametric estimation; recursive estimation; E4; G12; C12 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eme:aecozz:s0731-90532021000043b011

DOI: 10.1108/S0731-90532021000043B011

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