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The Rational Expectations Hypothesis of the Term Structure: Reconciling the Evidence

Author

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  • Tzavalis, Elias
  • Wickens, Michael

Abstract

The main aim of this paper is to test the rational expectations hypothesis of the term structure (REHTS). Existing empirical studies of the REHTS provide inconsistent evidence. Tests based on the local expectations hypothesis (LEH) version of the REHTS tend to be far less supportive than those based on the return to maturity expectations hypothesis (RTMEH), especially when they concern the short-run implications of the hypothesis. This paper explains the differences between these alternative versions of the REHTS and estimates a number of models to try to explain the inconsistencies in previous results. Our conclusions are that the most probable cause of these differences is the failure to take account of the presence of a time-varying term premium. Once this is accounted for both short-run and long-run evidence is found to support the REHTS. Estimates of variance bounds of the term premium suggest that it may not vary sufficiently to be the sole explanation for the differences.

Suggested Citation

  • Tzavalis, Elias & Wickens, Michael, 1994. "The Rational Expectations Hypothesis of the Term Structure: Reconciling the Evidence," Discussion Papers 9402, University of Exeter, Department of Economics.
    • Handle: RePEc:exe:wpaper:9402
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    Cited by:

    1. Theis Lange, 2009. "First and second order non-linear cointegration models," CREATES Research Papers 2009-04, Department of Economics and Business Economics, Aarhus University.
    2. Tzavalis, Elias & Wickens, M. R., 1996. "Forecasting inflation from the term structure," Journal of Empirical Finance, Elsevier, vol. 3(1), pages 103-122, May.

    More about this item

    Keywords

    Term structure; rational expectations; cointegration; VAR.;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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