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Testing the expectations hypothesis and explaining the determinants of term premia: evidence from the Indian money market

Author

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  • Golaka C. Nath
  • Vardhana Pawaskar
  • Manoj Dalvi
  • Manoel Pacheco

Abstract

The pure expectations hypothesis states that the current yields on bonds with different maturities reflect investor expectations of future interest rates. Analysing the short-term inter-bank rates in a Vector Error Correction Model (VECM), the study could reject the pure as well as the general expectations theory in case of the 1 month and 3 months rates but not in case of 14 day rates. The term premia is found to be time-varying. The study attempts to quantify and decompose the term premia, inherent in the money market rates. The study uses the market spreads derived from the swap market, T-Bills, and CD markets to understand the level of decomposition of the term premia. A latent factor model was used to break down the term premia and decompose the same into credit and liquidity risk factors by using information from related money market instruments.

Suggested Citation

  • Golaka C. Nath & Vardhana Pawaskar & Manoj Dalvi & Manoel Pacheco, 2021. "Testing the expectations hypothesis and explaining the determinants of term premia: evidence from the Indian money market," Applied Economics, Taylor & Francis Journals, vol. 53(41), pages 4750-4768, September.
    • Handle: RePEc:taf:applec:v:53:y:2021:i:41:p:4750-4768
    DOI: 10.1080/00036846.2021.1907288
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