Arbitrage-based estimation of nonstationary shifts in the term structure of interest rates

Article Abstract:

The purpose of this paper is to provide a test of a state-dependent multinomial model of intertemporal changes in the term structure of interest rates. The theoretical background for the model comes from Ho and Lee (1986). The current paper extends their model in several significant ways. First, we perform diagnostic tests on the data to demonstrate that the empirical results reject a binomial model in favor of a trinomial one. After theoretically deriving the appropriate trinomial model, the current paper extends their model to allow for state-dependent shifts which are determined by the set of ex ante observable state variables. The methodology for the study utilizes OLS regressions to identify the exogenous explanatory variables which drive the hypothesized trinomial process of term structure evolution. The empirical tests indicate that the set of state variables explains a significant portion of the variability in the shifts of the term structure over time. The model also identifies and quantifies a set of variables which impact on changes in the term structure of interest rates. (Reprinted by permission of the authority.)

Arbitrage

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New hope for the expectations hypothesis of the term structure of interest rates

Article Abstract:

Survey data on the interest rate expectations permit separate testing of the two alternative hypotheses in traditional term structure tests: that the expectations hypothesis fails, and that expected future interest rates are ex post inefficient forecasts. We find that the source of the spread's poor predictions of future interest rates varies with maturity. At short maturities the expectations hypothesis fails. At long maturities, however, changes in the yield curve reflect changes in expected future rates one-for-one, an implication of the expectations hypothesis. This result confirms earlier findings that long rates underreact to short rates, but now it cannot be attributed to term premia. (Reprinted by permission of the publisher.)

Rational expectations (Economics)

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A defense of traditional hypotheses about the term structure of interest rates

Article Abstract:

A study by Cox, Ingersoll, and Ross indicated that theories explaining term structure of interest rates are contradictory. Their study was entirely theoretical and had the effect of dismissing the validity of empirical work based on models. In refutation of the research performed by Cox, Ingersoll, and Ross, this research focuses on the continuing value of empirical research. The argument sustains the view that empirical literature aims at approximations and expectations, not to mathematical precision.

Economic aspects, Investments, Capital market, Capital markets, Financial research

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