The Rational Expectations Hypothesis of the Term Structure: The Evidence

London Business School Institute of Finance and Accounting Working Paper 185

Posted: 16 Sep 1999

See all articles by Elias Tzavalis

Elias Tzavalis

University of London - Queen Mary - Department of Economics

Michael Wickens

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

Abstract

The main aim of this paper is to test the rational expectations hypothesis of the term structure (REHTS). Existing empirical studies of the REHTS provide inconsistent evidence. Tests based on the local expectations hypothesis (LEH) version of the REHTS tend to be far less supportive than those based on the return to maturity expectations hypothesis (RTMEH), especially when they concern the short-run implications of the hypothesis. This paper explains the differences between these alternative versions of the REHTS and estimates a number of models to try to explain the inconsistencies in previous results. Our conclusions are that the most probable cause of these differences is the failure to take account of the presence of a time-varying term premium. Once this is accounted for, both short-run and long-run evidence is found to support the REHTS. Estimates of variance bounds of the term premium suggest that it may not vary sufficiently to be the sole explanation for the differences.

JEL Classification: G1, G12

Suggested Citation

Tzavalis, Elias and Wickens, Michael, The Rational Expectations Hypothesis of the Term Structure: The Evidence. London Business School Institute of Finance and Accounting Working Paper 185. Available at SSRN: https://ssrn.com/abstract=5479

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 Cardiff; Centre for Economic Policy Research (CEPR) ( 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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