Expectations and the Term Structure of Interest Rates: Evidence and Implications

47 Pages Posted: 2 Dec 2012

See all articles by Robert G. King

Robert G. King

Boston University - Department of Economics; Federal Reserve Bank of Richmond - Research Department; National Bureau of Economic Research (NBER)

André Kurmann

Drexel University - LeBow College of Business

Date Written: 2002

Abstract

Although the expectations theory is the dominant model of long-term interest rate determination, empirical studies often reject its implications. Taking the theory as a benchmark, the authors work to quantify the influence of expectations. They find support for two key implications: that permanent shifts in short-term rates should have a one-for-one effect on long-term rates and that the spread between long and short rates should reflect temporary shifts in short rates. They also find evidence that a common stochastic trend in interest rates is particularly important for the long rate and that temporary deviations from this trend are particularly important for the spread. Although detailed rational expectations restrictions implied by the term structure theory are rejected for U.S. data, the authors nevertheless conclude that the expectations theory remains a useful tool in applied contexts and provide two rules of thumb for practitioners.

Suggested Citation

King, Robert G. and Kurmann, André, Expectations and the Term Structure of Interest Rates: Evidence and Implications (2002). FRB Richmond Economic Quarterly, vol. 88, no. 4, Fall 2002, pp. 49-95, Available at SSRN: https://ssrn.com/abstract=2183366

Robert G. King (Contact Author)

Boston University - Department of Economics ( email )

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Boston, MA 02215
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Federal Reserve Bank of Richmond - Research Department

P.O. Box 27622
Richmond, VA 23261
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National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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André Kurmann

Drexel University - LeBow College of Business ( email )

School of Economics
3220 Market Street
Philadelphia, PA 19104
United States

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