Rational expectation hypothesis: empirical evidence from government debt market in India

Kakali Kanjilal

International Journal of Indian Culture and Business Management, 2014, vol. 9, issue 3, 353-370

Abstract: This article tests the validity of rational expectations hypothesis (REH) for government securities market in India for the period Jul-97 through Feb-04. REH states that the return on longer-term instrument is equal to the expected average of the short-term instruments which is expected to occur over the life of the long-term instrument. The theory has been empirically tested by a large number of researchers, mostly for developed countries and the findings are often controversial. The study tests the expectation hypothesis theory through establishing a cointegrating relationships for the government securities market consisting of short-term, medium-term and long-term instruments. It used zero coupon interest rates of one month, three months, six months, three years and ten years of maturities. The article finds four cointegrating relationships suggesting the validity of expectation hypothesis for the government securities market in India. This indeed ensures the smooth functioning of debt market in India which gives an indication that the yield curve should serve as an indicator to the monetary policymakers to manage inflation and to influence the aggregate demand in the economy.

Keywords: term structure; rational expectation hypothesis; REH; cointegration; India; government securities markets; returns; long term instruments; short term instruments; medium term instruments; zero coupons; interest rates; cointegrating relationships; government debt markets; yield curves; monetary policy makers; inflation; aggregate demand. (search for similar items in EconPapers)
Date: 2014
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