Expectations Puzzle, Time-varying Risk Premia, and Dynamic Models of the Term Structure
University of North Carolina (UNC) at Chapel Hill - Finance Area
Kenneth J. Singleton
Stanford University-Graduate School of Business
January 24, 2001
Stern School of Business, New York University, and Graduate School of Business, Stanford University
Though linear projections of returns on the slope of the yield curve have contradicted the implications of the traditional "expectations theory," we show that these findings are not puzzling relative to a large class of richer dynamic term structure models. Specifically, we are able to match all of the key empirical findings reported by Fama and Bliss and Campbell and Shiller, among others, within large subclasses of affine and quadratic-Gaussian term structure models. Key to this matching are parameterizations of the market prices of risk that let us separately "control" the shape of the mean yield curve and the correlation structure of excess returns with the slope of the yield curve. The risk premiums have a simple form consistent with Fama's findings on the predictability of forward rates, and are shown to also be consistent with interest rate, feedback rules used by a monetary authority in setting monetary policy.
Number of Pages in PDF File: 32
JEL Classification: E43, E52, C51, C52working papers series
Date posted: November 10, 2000
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