We examine and test the validity of the expectation hypothesis of the term structure (EHTS) of interest rates in Saudi Arabia using the traditional single equation approach, Campbell and Shiller methodology, Error Correction Model, and monthly data over the period June 1983 to December 2014. The results of the single equation approach indicate that the test of validity of the expectation hypothesis cannot be rejected for all maturities. We also find that the validity of the EHTS of interest rates is supported through the stationarity of the term spreads between short- and long-term interest rates. Moreover, the cointegration test reveals the existence of a cointegration relationship between short- and long-term interest with $\left(1-1\right)$ cointegrating vector, suggesting the validity EHTS of interest rates. Policy implications based on the empirical results suggest that the transparency of monetary policy in Saudi Arabia and the effective role of the Saudi Arabian Monetary Authority (SAMA) in conducting monetary policy increase the predictive power of market participants of future movements of short-term interest rates.

This study specifies a modified version of the monetary approach to the balance of payments (MABP) model with free capital flow and fixed exchange rates for Saudi Arabia, and tests the independence of monetary policy of its central bank using annual data from 1960 to 1994. Further, capital flight and speculative inventory behaviour of importers of consumer and capital goods in Saudi Arabia are also tested to the expected exchange rate depreciation during the periods of exchange turmoil against the riyal. The results of this study indicate that Saudi Arabian Monetary Authority has at best a weak control on its money supply which is in accord with one of the predictions of MABP theory. Further, the study found little support to the speculative inventory behaviour of the importers of consumer and capital goods in Saudi Arabia against exchange rate depreciation of the riyal. However, the results suggest that the expected change in exchange rate depreciation has a positive and a significant impact on capital flight in Saudi Arabia.