The Expectation Hypothesis of the Term Structure of Very Short-Term Rates: Statistical Tests and Economic Value

FRB of St. Louis Working Paper No. 2006-061B

42 Pages Posted: 6 Dec 2006

See all articles by Pasquale Della Corte

Pasquale Della Corte

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Lucio Sarno

City University London - Sir John Cass Business School; Centre for Economic Policy Research (CEPR)

Daniel L. Thornton

Federal Reserve Bank of St. Louis - Research Division

Date Written: July 2007

Abstract

This paper re-examines the validity of the Expectation Hypothesis (EH) of the term structure of US repo rates ranging in maturity from overnight to three months. We extend the work of Longstaff (2000) in two directions: (i) we implement statistical tests designed to increase test power in this context; (ii) we assess the economic value of departures from the EH based on criteria of profitability and economic significance. The EH is rejected throughout the term structure examined on the basis of the statistical tests. The results of our economic analysis are less uniform and more favorable to the EH, suggesting that the statistical rejections of the EH are not economically significant for rates with maturities of one month and longer.

Keywords: Expectation Hypothesis, Term Structure of Interest Rates, Vector Autoregression, Economic Value

JEL Classification: G10, E43

Suggested Citation

Della Corte, Pasquale and Sarno, Lucio and Thornton, Daniel L., The Expectation Hypothesis of the Term Structure of Very Short-Term Rates: Statistical Tests and Economic Value (July 2007). FRB of St. Louis Working Paper No. 2006-061B. Available at SSRN: https://ssrn.com/abstract=949208 or http://dx.doi.org/10.2139/ssrn.949208

Pasquale Della Corte

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London, SW7 2AZ
United Kingdom
+44(0)20 759 49331 (Phone)

HOME PAGE: http://sites.google.com/view/pasqualedellacorte

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Lucio Sarno

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Daniel L. Thornton (Contact Author)

Federal Reserve Bank of St. Louis - Research Division ( email )

411 Locust St
Saint Louis, MO 63011
United States
314-444-8582 (Phone)
314-444-8731 (Fax)

HOME PAGE: http://research.stlouisfed.org/econ/thornton/

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