Working Paper: CEPR ID: DP5259
Authors: Lucio Sarno; Daniel L. Thornton; Giorgio Valente
Abstract: This paper tests the expectations hypothesis (EH) using US monthly data for bond yields spanning the 1952-2003 sample period and ranging in maturity from 1 month to 10 years. We apply the Lagrange multiplier test developed by Bekaert and Hodrick (2001) and extend it to increase the test power: (a) by introducing economic variables as conditioning information; and (b) by using more than two bond yields in the model and testing the EH jointly on more than one pair of yields. While the conventional bivariate procedure provides mixed results, the more powerful testing procedures suggest rejection of the EH throughout the maturity spectrum examined.
Keywords: expectations hypothesis; term structure of interest rates; vector autoregression
JEL Codes: E43; G10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Number of bond yields included (G12) | Power of LM tests (C51) |
| Rejection of EH (D81) | Complexity of term structure of interest rates (E43) |
| Short-term rates (E43) | Long-term rates (E43) |
| Macroeconomic variables (E19) | Long-term rates (E43) |
| Inclusion of macroeconomic variables (E19) | Rejection of EH (D81) |