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The rational expectations hypothesis and the cross-section of bond yields

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  • Richard Harris

Abstract

In the context of the bond market, empirical tests of the rational expectations hypothesis (REH) have without exception been tests of the time-series properties of interest rates. However, the REH also imposes restrictions on the cross-section of bond yields at each point in time. This study tests these restrictions using the Fama and MacBeth repeated cross-section regression procedure. Specifically, a long series of monthly cross-section regressions is estimated using zero coupon bond yield data for maturities from two months to thirty-five years. The REH is tested using the time-series average of the estimated slope parameter in the cross-section regressions. The maturity-specific risk premium is proxied by the time-series volatility of excess returns for each bond maturity. Time-variation in the risk premium is allowed for through time-variation in the volatility of excess returns, and in the market price of risk. While the risk premium proxy is significant in explaining the cross-section of excess returns, the REH is very strongly rejected.

Suggested Citation

  • Richard Harris, 2004. "The rational expectations hypothesis and the cross-section of bond yields," Applied Financial Economics, Taylor & Francis Journals, vol. 14(2), pages 105-112.
    • Handle: RePEc:taf:apfiec:v:14:y:2004:i:2:p:105-112
    DOI: 10.1080/0960310042000176371
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    Cited by:

    1. Arielle Beyaert & Juan Jose Perez-Castejon, 2009. "Markov-switching models, rational expectations and the term structure of interest rates," Applied Economics, Taylor & Francis Journals, vol. 41(3), pages 399-412.
    2. George Halkos & Stephanos Papadamou, 2007. "Significance of risk modelling in the term structure of interest rates," Applied Financial Economics, Taylor & Francis Journals, vol. 17(3), pages 237-247.
    3. Kostyantyn MALYSHENKO & Vadim MALYSHENKO & Elena Yu. PONOMAREVA & Marina ANASHKINA, 2019. "Analysis of the stock market anomalies in the context of changing the information paradigm," Eastern Journal of European Studies, Centre for European Studies, Alexandru Ioan Cuza University, vol. 10, pages 239-270, June.

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