The Rational Expectations Hypothesis of the Term Structure: Reconciling the Evidence

Elias Tzavalis and Michael Wickens

Discussion Papers from University of Exeter, Department of Economics

Abstract: The main aim of this paper is to test the rational expectations hypothesis of the term structure (REHTS). Existing empirical studies of the REHTS provide inconsistent evidence. Tests based on the local expectations hypothesis (LEH) version of the REHTS tend to be far less supportive than those based on the return to maturity expectations hypothesis (RTMEH), especially when they concern the short-run implications of the hypothesis. This paper explains the differences between these alternative versions of the REHTS and estimates a number of models to try to explain the inconsistencies in previous results. Our conclusions are that the most probable cause of these differences is the failure to take account of the presence of a time-varying term premium. Once this is accounted for both short-run and long-run evidence is found to support the REHTS. Estimates of variance bounds of the term premium suggest that it may not vary sufficiently to be the sole explanation for the differences.

Keywords: Term structure; rational expectations; cointegration; VAR. (search for similar items in EconPapers)
JEL-codes: C32 C52 (search for similar items in EconPapers)
Date: 1994
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:exe:wpaper:9402

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