On Biases in Tests of the Expecations Hypothesis of the Term Structure of Interest Rates

41 Pages Posted: 20 Jul 2000 Last revised: 12 Jul 2010

See all articles by Geert Bekaert

Geert Bekaert

Columbia Business School - Finance and Economics

Robert J. Hodrick

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

David A. Marshall

Federal Reserve Bank of Chicago; University of Chicago - Booth School of Business

Date Written: January 1996

Abstract

We document extreme bias and dispersion in the small sample distributions of five standard regression tests of the expectations hypothesis of the term structure of interest rates. These biases derive from the extreme persistence in short interest rates. We derive approximate analytic expressions for these biases, and we characterize the small-sample distributions of these test statistics under a simple first-order autoregressive data generating process for the short rate. The biases are also present when the short rate is modeled with a more realistic regime-switching process. The differences between the small-sample distributions of test statistics and the asymptotic distributions partially reconcile the different inferences drawn when alternative tests are used to evaluate the expectations hypothesis. In general, the test statistics reject the expectations hypothesis more strongly and uniformly when they are evaluated using the small-sample distributions, as compared to the asymptotic distributions.

Suggested Citation

Bekaert, Geert and Hodrick, Robert J. and Marshall, David Aaron, On Biases in Tests of the Expecations Hypothesis of the Term Structure of Interest Rates (January 1996). NBER Working Paper No. t0191. Available at SSRN: https://ssrn.com/abstract=225099

Geert Bekaert (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Robert J. Hodrick

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

365 Fifth Avenue, 5th Floor
New York, NY 10016-4309
United States

David Aaron Marshall

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604-1413
United States
312-322-5111 (Phone)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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