Expectations Puzzle, Time-Varying Risk Premia, and Dynamic Models of the Term Structure

Stern School of Business, New York University, and Graduate School of Business, Stanford University

32 Pages Posted: 10 Nov 2000

See all articles by Qiang Dai

Qiang Dai

University of North Carolina (UNC) at Chapel Hill - Finance Area

Kenneth J. Singleton

Stanford University - Graduate School of Business

Date Written: January 24, 2001

Abstract

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.

JEL Classification: E43, E52, C51, C52

Suggested Citation

Dai, Qiang and Singleton, Kenneth J., Expectations Puzzle, Time-Varying Risk Premia, and Dynamic Models of the Term Structure (January 24, 2001). Stern School of Business, New York University, and Graduate School of Business, Stanford University, Available at SSRN: https://ssrn.com/abstract=242607 or http://dx.doi.org/10.2139/ssrn.242607

Qiang Dai

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-7182 (Phone)

Kenneth J. Singleton (Contact Author)

Stanford University - Graduate School of Business ( email )

Knight Management Center
655 Knight Way
Stanford, CA 94305-7298
United States
650-723-5753 (Phone)

HOME PAGE: http://www.stanford.edu/~kenneths

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