Tests of the expectations hypothesis: Resolving the anomalies when the short-term rate is the federal funds rate

Thornton, Daniel L.

doi:10.1016/j.jbankfin.2004.09.005

Cited by 39 publications

(25 citation statements)

References 40 publications

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“…The ORH is not supported by evidence in the United States. Poole, Rasche, and Thornton (2002) show that the coefficient on a surprise change in the Federal Reserve Board's federal funds rate target for long-term rates is much smaller than that for short-term rates. Moreover, for rates longer than 12 months the estimated response is not statistically significant.…”

Section: Implications Of the Rejection Of The Eh For Monetary Pomentioning

confidence: 99%

Testing the Expectations Hypothesis: Some New Evidence for Japan

Thornton¹

2005

ICPSR Data Holdings

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this paper investigates the EH by estimating a bivariate vector autoregression (VAR) for the longterm and short-term interest rates and testing the restrictions implied by the EH. This test was first suggested by Campbell and Shiller (1987); however, the procedure used here was developed by . 1 Second, this paper deals directly with the issue of stationarity. While stationarity is frequently considered in testing the EH, its implications for the EH are seldom discussed. This paper attempts to fill this void. As a matter of theory, many economists and financial specialists appear to believe that interest rates are stationary. If they are not, the role played by the EH in monetary policy may be diminished.As a practical matter, interest rates tend to exhibit considerable persistence. Indeed, the null hypothesis of nonstationarity is frequently not rejected even in relatively large, finite samples. This is particularly important for Japanese interest rates because they exhibit considerable persistence at the monthly frequency. It is well known, however, that tests of unit roots may have low power. Moreover, many financial market economists argue that interest rates are stationary on theoretical grounds. Given the differences of opinion about whether interest rates are stationary in general, the VAR test is applied under the assumption that interest rates are either stationary or nonstationary. The issue of stationarity is important only if the conclusions concerning the EH differ markedly depending on the assumption made.1 Several of the tests of the EH that are frequently used have low power and, more importantly, tend to generate results that can give a misleading impression of the strength or weakness of the EH. For a more detailed discussion of this problem, see Thornton

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Section: Implications Of the Rejection Of The Eh For Monetary Pomentioning

confidence: 99%

Testing the Expectations Hypothesis: Some New Evidence for Japan

Thornton¹

2005

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“…On the other hand, our market data-based results might be seen as the corresponding upper bound. The mixed empirical evidence together with the empirical failure of the expectations theory (Sarno, Thornton, & Valente, 2007;Thornton, 2005) and the restrictive theoretical assumptions underlying preferred habitat (Thornton, 2012) imply that our understanding of how QE led to lower bond yields is still incomplete. For example, Gagnon, Raskin, Remache, and Sack (2011) and D'Amico, English, Lopez-Salido, and Nelson (2012) support a term-premium explanation, whereas Bauer and Rudebusch (2013) favour the signalling channel.…”

Section: Endnotesmentioning

confidence: 99%

Treasuries variance decomposition and the impact of monetary policy

et al. 2019

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This paper investigates the effect of monetary policy shifts on Treasuries over the last three decades. We decompose unexpected excess returns on 2‐, 5‐, and 10‐year Treasuries in three components related to revisions in expectations (news) about future excess returns, inflation, and real interest rates. We evaluate the impact of conventional and unconventional monetary policy shocks on returns and their components. Our results indicate that expansionary monetary policy shocks are associated with declining inflation expectations and higher Treasuries' returns.

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“…Section II presents the essential ingredients of the LM test proposed by Bekaert and Hodrick (2001). Section III briefly describes the data and preliminary unit root tests on our bond yields designed to 1 Moreover, Kool and Thornton (2004) and Thornton (2005) show how conventional tests may have generated misleading results in applied work. 2 In a previous draft of this paper, we used the data set used by Campbell and Shiller (1991) in their seminal work to see how the conclusions of the EH are affected by the test used.…”

Section: Introductionmentioning

confidence: 99%

The Empirical Failure of the Expectations Hypothesis of the Term Structure of Bond Yields

Sarno¹,

Thornton²,

Valente³

2007

J. Financ. Quant. Anal.

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105

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This paper tests the expectations hypothesis (EH) using U.S. monthly data for bond yields spanning the 1952-2003 sample period and ranging in maturity from one month to 10 years. We apply the Lagrange multiplier test developed by Bekaert and Hodrick (2001) and extend it to increase the test power by introducing economic variables as conditioning information and 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.

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Tests of the expectations hypothesis: Resolving the anomalies when the short-term rate is the federal funds rate

Cited by 39 publications

References 40 publications

Testing the Expectations Hypothesis: Some New Evidence for Japan

Testing the Expectations Hypothesis: Some New Evidence for Japan

Treasuries variance decomposition and the impact of monetary policy

The Empirical Failure of the Expectations Hypothesis of the Term Structure of Bond Yields

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