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The Term Structure of Interest Rates in a Partially Observable Economy

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  • DAVID FELDMAN

Abstract

This paper investigates the term structure of interest rates in a multiperiod production and exchange economy with incomplete information. Unable to observe their stochastic investment opportunities, investors engage in dynamic Bayesian inference. This results in the endogenous identification of a more complex production function which generates a richer term structure, resembling the one that actual market prices imply. In addition, this paper introduces a characteristic function of the term structure and demonstrates that, in contrast with a fully observable economy, the widely investigated expectations hypothesis holds true only if interest rates are nonstochastic.

Suggested Citation

  • David Feldman, 1989. "The Term Structure of Interest Rates in a Partially Observable Economy," Journal of Finance, American Finance Association, vol. 44(3), pages 789-812, July.
    • Handle: RePEc:bla:jfinan:v:44:y:1989:i:3:p:789-812
    DOI: 10.1111/j.1540-6261.1989.tb04391.x
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