Alternative Term Structure Models for Reviewing Expectations Puzzles

Research Paper Number No. 305, Quantitative Finance Research Centre, University of Technology, Sydney

28 Pages Posted: 29 Oct 2012

See all articles by Christina Sklibosios Nikitopoulos

Christina Sklibosios Nikitopoulos

University of Technology Sydney - Business School; Financial Research Network (FIRN)

Eckhard Platen

University of Technology, Sydney (UTS) - Finance Discipline Group; University of Technology Sydney, School of Mathematical and Physical Sciences; Financial Research Network (FIRN)

Multiple version iconThere are 2 versions of this paper

Date Written: March 1, 2012

Abstract

According to the expectations hypothesis, the forward rate is equal to the expected future short rate, an argument that is not supported by most empirical studies that demonstrate the existence of term premiums. An alternative arbitrage-free term structure model for reviewing the expectations hypothesis is presented and tractable expressions for time-varying term premiums are obtained. The model is constructed under the real-world probability measure and depends on two stochastic factors: the short rate and the market price of risk. The model suggests that for short maturities the short rate contribution determines the term premiums, while for longer maturities, the contribution of the market price of risk dominates.

Keywords: expectations hypothesis, time-varying term premiums, real-world probability measure, market price of risk

JEL Classification: G13

Suggested Citation

Sklibosios Nikitopoulos, Christina and Platen, Eckhard, Alternative Term Structure Models for Reviewing Expectations Puzzles (March 1, 2012). Research Paper Number No. 305, Quantitative Finance Research Centre, University of Technology, Sydney, Available at SSRN: https://ssrn.com/abstract=2167964 or http://dx.doi.org/10.2139/ssrn.2167964

Christina Sklibosios Nikitopoulos (Contact Author)

University of Technology Sydney - Business School ( email )

15 Broadway, Ultimo
Sydney 2007, New South Wales
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Eckhard Platen

University of Technology, Sydney (UTS) - Finance Discipline Group ( email )

Broadway
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Sydney, NSW 2007, 2007
Australia
+61 2 9514 7759 (Phone)

HOME PAGE: http://datasearch.uts.edu.au/business/finance/staff/StaffDetails.cfm?UnitStaffId=90

University of Technology Sydney, School of Mathematical and Physical Sciences ( email )

P.O. Box 123
Broadway
Sydney, New South Wales 2007
Australia
+61 (02) 9514 2271 (Phone)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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