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Estimation of the specification error in the expectations theory of the term structure

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  • Paul Johnson

Abstract

This paper asks, 'how false is the expectations theory of the term structure?'. Most previous work has asked, 'is the expectations theory true?' and finds that it is not. The goal here is to gauge the economic importance of these answers in the negative by estimating the specification error in the expectations theory. The variance of the estimated specification error (suitably normalized) provides a metric for assessing the validity of the model. I find that, while the expectations theory can be rejected, the importance of the rejection is much less than that implied by previous studies, so that the theory may still be a useful tool for understanding the relationships between interest rates at different maturities.

Suggested Citation

  • Paul Johnson, 1997. "Estimation of the specification error in the expectations theory of the term structure," Applied Economics, Taylor & Francis Journals, vol. 29(9), pages 1239-1247.
    • Handle: RePEc:taf:applec:v:29:y:1997:i:9:p:1239-1247
    DOI: 10.1080/00036849700000014
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    References listed on IDEAS

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    1. Phillips, P.C.B., 1986. "Understanding spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 33(3), pages 311-340, December.
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    6. Shea, Gary S, 1992. "Benchmarking the Expectations Hypothesis of the Interest-Rate Term Structure: An Analysis of Cointegration Vectors," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(3), pages 347-366, July.
    7. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(1), pages 173-224.
    8. Hall, Anthony D & Anderson, Heather M & Granger, Clive W J, 1992. "A Cointegration Analysis of Treasury Bill Yields," The Review of Economics and Statistics, MIT Press, vol. 74(1), pages 116-126, February.
    9. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, vol. 55(2), pages 391-407, March.
    10. Engsted, Tom & Tanggaard, Carsten, 1994. "Cointegration and the US term structure," Journal of Banking & Finance, Elsevier, vol. 18(1), pages 167-181, January.
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    Cited by:

    1. Mao-Wei Hung & Jr-Yan Wang, 2011. "Loss aversion and the term structure of interest rates," Applied Economics, Taylor & Francis Journals, vol. 43(29), pages 4623-4640.
    2. 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.
    3. Petko Kalev & Brett Inder, 2006. "The information content of the term structure of interest rates," Applied Economics, Taylor & Francis Journals, vol. 38(1), pages 33-45.
    4. repec:bla:jecsur:v:16:y:2002:i:3:p:301-55 is not listed on IDEAS

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