Overconfidence and the Rational Expectations Model of the Term Structure of Interest Rates

27 Pages Posted: 3 Sep 2013

See all articles by George Bulkley

George Bulkley

University of Bristol

Richard D. F. Harris

University of Bristol

Vivekanand Nawosah

University of Essex

Date Written: June 3, 2013

Abstract

We propose a behavioral explanation for the widely reported rejection of the rational expectations model of the term structure of interest rates. We distinguish between public and private information and show that overconfidence among investors about the precision of private information can account for the empirical failure of the rational expectations model. Using a simulation experiment calibrated with data on US interest rates, we demonstrate that only a small degree of investor overconfidence is needed to replicate the principle features of the rejections of the rational expectations model that have been documented in different tests in the empirical literature.

Keywords: Rational expectations hypothesis, Term structure of interest rates, Behavioural bias

JEL Classification: C11, G14

Suggested Citation

Bulkley, George and Harris, Richard D. F. and Nawosah, Vivekanand, Overconfidence and the Rational Expectations Model of the Term Structure of Interest Rates (June 3, 2013). Available at SSRN: https://ssrn.com/abstract=2320154 or http://dx.doi.org/10.2139/ssrn.2320154

George Bulkley (Contact Author)

University of Bristol ( email )

United Kingdom

Richard D. F. Harris

University of Bristol ( email )

University of Bristol,
Senate House, Tyndall Avenue
Bristol, BS8 ITH
United Kingdom

Vivekanand Nawosah

University of Essex ( email )

Wivenhoe Park
Colchester CO4 3SQ
United Kingdom

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