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Investigating the expectation hypothesis and the risk premium dynamics: new evidence for Brazil

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  • João F. Caldeira

    (Universidade Federal do Rio Grande do Sul & CNPq)

Abstract

We re-examine the validity of the expectation hypothesis (EH) of the term structure for the Brazilian fixed income market, using data from January 2000 to June 2017. Furthermore, we investigated the out-of-sample predictability of bond excess returns by means of common factors extracted from a cross-section of Brazilian macro-variables and zero-coupon interest rates. The EH is rejected throughout the term structure examined on the basis of the statistical tests across the entire maturity spectrum considered. Our results confirm previous findings, mostly obtained for developed markets, that a linear combination of forward rates and macroeconomic factors can explain a substantial portion of movements in bonds excess returns, contributing novel and up-to-date evidence from a large and dynamic emerging bond market, such as Brazil. Furthermore, we find that the factor extracted from a large panel of macroeconomic variables generates significant gains in forecasting bond excess returns relative to yield curve information.

Suggested Citation

  • João F. Caldeira, 2020. "Investigating the expectation hypothesis and the risk premium dynamics: new evidence for Brazil," Empirical Economics, Springer, vol. 59(1), pages 395-412, July.
    • Handle: RePEc:spr:empeco:v:59:y:2020:i:1:d:10.1007_s00181-019-01629-0
    DOI: 10.1007/s00181-019-01629-0
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    More about this item

    Keywords

    Expectation hypothesis; Bond risk premia; Factor models; Excess return predictability; Out-of-sample forecasts;
    All these keywords.

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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