Surprises, sentiments, and the expectations hypothesis of the term structure of interest rates

Cathy Yi-Hsuan Chen () and Thomas C. Chiang ()
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Cathy Yi-Hsuan Chen: Humboldt-Universität zu Berlin
Thomas C. Chiang: Drexel University

Review of Quantitative Finance and Accounting, 2017, vol. 49, issue 1, No 1, 28 pages

Abstract: Abstract This study shows that time-varying coefficients in the term structure of interest rates equation are correlated with the time-varying term premiums (TVTP) and expectation error (EE). Consistent with Froot (J Finance 44:283–305, 1989), TVTP and EE are the main factors that cause variations in the expectations hypothesis. Once the TVTP and the EE are appropriately incorporated into the model, the GARCH-M evidence fades away. This study documents that investors’ sentiment and macroeconomic surprises are the main driving forces behind the TVTP and EE. Evidence of significant sentiment and its interacting with macroeconomic surprises shed some light on the bias due to behavioral variations.

Keywords: Expectations hypothesis; Time-varying coefficient model; Sentiment; Expectation error; Term premium (search for similar items in EconPapers)
JEL-codes: E43 G12 G14 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (1)

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DOI: 10.1007/s11156-016-0584-y

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