Explaining the Failures of the Term Spread Models of the Rational Expectations Hypothesis of the Term Structure

JOURNAL OF MONEY, CREDIT, AND BANKING, Vol 28 No 3, August 1997

Posted: 7 Apr 1997

See all articles by Elias Tzavalis

Elias Tzavalis

University of London - Queen Mary - Department of Economics

Michael Wickens

University of York; Cardiff Business School; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Abstract

Contrary to the predictions of the rational expectations hypothesis of the term structure of interest rates, empirical evidence suggests that the term spread between long and short rates fails to forecast future movements of long term rates although its forecasts of future short term rates are in the correct direction. In this paper, we show that this puzzling behaviour of the term spread alone can be explained by a time-varying term premium which is correlated with the term spread. Once this is accounted for neither expression of the expectations hypothesis is against the predictions of the theory.

JEL Classification: C22, C32, C52, E43

Suggested Citation

Tzavalis, Elias and Wickens, Michael, Explaining the Failures of the Term Spread Models of the Rational Expectations Hypothesis of the Term Structure. JOURNAL OF MONEY, CREDIT, AND BANKING, Vol 28 No 3, August 1997. Available at SSRN: https://ssrn.com/abstract=3860

Elias Tzavalis (Contact Author)

University of London - Queen Mary - Department of Economics ( email )

Mile End Road
London, E1 4NS
United Kingdom

HOME PAGE: http//www.qmw.ac.uk/~ugte184/

Michael Wickens

University of York ( email )

Heslington
York, YO10 5DD
United Kingdom
+44 1904 433 764 (Phone)
+44 1904 433 575 (Fax)

Cardiff Business School ( email )

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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