Testing the expectations hypothesis and explaining the determinants of term premia: evidence from the Indian money market

Golaka C. Nath, Vardhana Pawaskar, Manoj Dalvi and Manoel Pacheco

Applied Economics, 2021, vol. 53, issue 41, 4750-4768

Abstract: The pure expectations hypothesis states that the current yields on bonds with different maturities reflect investor expectations of future interest rates. Analysing the short-term inter-bank rates in a Vector Error Correction Model (VECM), the study could reject the pure as well as the general expectations theory in case of the 1 month and 3 months rates but not in case of 14 day rates. The term premia is found to be time-varying. The study attempts to quantify and decompose the term premia, inherent in the money market rates. The study uses the market spreads derived from the swap market, T-Bills, and CD markets to understand the level of decomposition of the term premia. A latent factor model was used to break down the term premia and decompose the same into credit and liquidity risk factors by using information from related money market instruments.

Date: 2021
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DOI: 10.1080/00036846.2021.1907288

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