Working Paper: NBER ID: w6147
Authors: Geert Bekaert; Robert J. Hodrick; David A. Marshall
Abstract: We examine the empirical evidence on the expectations hypothesis of the term structure of interest rates in the United States, the United Kingdom, and Germany using the Campbell-Shiller (1991) regressions and a vector-autoregressive" methodology. We argue that anomalies in the U.S. term structure, documented by Campbell and Shiller (1991), may be due to a generalized peso problem in which a high-interest rate regime occurred less frequently in the sample of U.S. data than was rationally anticipated. We formalize this idea as a regime-switching model of short-term interest rates estimated with data" from seven countries. Technically, this model extends recent research on regime-switching models with state-dependent transitions to a cross-sectional setting. Use of the small sample distributions generated by the regime-switching model for inference considerably weakens the evidence against the expectations hypothesis, but it remains somewhat implausible that our data-generating process produced the U.S. data. However, a model that combines moderate time-variation in term premiums with peso-problem effects is largely consistent with term structure data from the U.S., U.K., and Germany.
Keywords: asset pricing; expectations hypothesis; term structure of interest rates
JEL Codes: G12; F3; E4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| frequency of high-interest rate regimes (E43) | anomalies in the US term structure (E43) |
| peso problem effects + moderate time-variation in term premiums (E43) | observed anomalies (B53) |
| frequency of inflationary episodes (E31) | robustness of expectations hypothesis (D84) |
| peso problem effects (I12) | rejection of expectations hypothesis (D84) |
| anomalies in the US term structure (E43) | expectations hypothesis (D84) |