The information content of the term structure of interest rates

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This paper presents the results of an alternative test of the rational expectations theory of the term structure of interest rates. Other researchers have also examined the validity of the expectations hypothesis of term structure. While there is more often rejection of the expectations hypothesis, no other theory (data-consistent with the entire yield curve) provides an empirically adequate explanation of this phenomenon. The study considers postwar US pure discount (zero coupons) bond yields with various maturities, from one month to 60 months. Based on the ex post formation of rational expectations, the expectations error is quantified and the level of truth of the expectations hypothesis tested, that is, the strength of the departure of the yield curve from the expectations theory. The results suggest that a significant amount of information available at no cost to market agents is not incorporated in forming people's expectations.

Document Type: Research Article


Affiliations: 1: Department of Accounting and Finance, Monash University, Caulfield, VIC 3145, Australia 2: Department of Econometrics and Business Statistics, Monash University, Caulfield, VIC 3145, Australia

Publication date: January 20, 2006

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