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Around and Around: The Expectations Hypothesis

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  • Mark Fisher
  • Christian Gilles

Abstract

We show how to construct arbitrage-free models of he term structure of interest rates in which various expectations hypotheses can hold. McCulloch (1993) provided a Gaussian non-Markovian example of the unbiased expectations hypothesis (U--EH), thereby contradicting the assertion by Cox, Ingersoll, and Ross (CIR, 1981) that only the so-called local expectations hypothesis could hold. We generalize that example in three ways: (i) We characterize the U--EH in terms of forward rates; (ii) we extend this characterization to a class of expectations hypotheses that includes all of those considered by CIR; and (iii) we construct stationary Markovian and non-Gaussian economies. The building block is a maturity-dependent vector that travels around a circle at a constant speed as maturity increases.

Suggested Citation

  • Mark Fisher & Christian Gilles, "undated". "Around and Around: The Expectations Hypothesis," Finance and Economics Discussion Series 1996-17, Board of Governors of the Federal Reserve System (U.S.), revised 04 Dec 2019.
    • Handle: RePEc:fip:fedgfe:1996-17
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    File URL: http://www.federalreserve.gov/pubs/feds/1996/199617/199617pap.pdf
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    References listed on IDEAS

    as
    1. Campbell, John Y, 1986. "A Defense of Traditional Hypotheses about the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 41(1), pages 183-193, March.
    2. Woodward, Susan E, 1983. "The Liquidity Premium and the Solidity Premium," American Economic Review, American Economic Association, vol. 73(3), pages 348-361, June.
    3. John Y. Campbell & Robert J. Shiller, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 58(3), pages 495-514.
    4. McCulloch, J Huston, 1993. "A Reexamination of Traditional Hypotheses about the Term Structure: A Comment," Journal of Finance, American Finance Association, vol. 48(2), pages 779-789, June.
    5. David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305, World Scientific Publishing Co. Pte. Ltd..
    6. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1981. "A Re-examination of Traditional Hypotheses about the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 36(4), pages 769-799, September.
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