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Discussion Paper Details

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Title: Time Variation in Term Premia: International Evidence

Author(s): Ron Jongen, Willem F C Verschoor and Christian C Wolff

Publication Date: March 2005

Keyword(s): EMS, expectations hypothesis, interest rate expectations, rationality, survey data, term structure and time-varying term premia

Programme Area(s): Financial Economics

Abstract: This paper examines the validity of the expectations hypothesis of the term structure of interest rates by means of a previously unexploited dataset of market expectations that covers a broad range of EMS versus non-EMS foreign currency deposits. Although we find strong evidence in favour of rejecting the ?pure? version of the expectations hypothesis, we still cannot reject the hypothesis that the forward rate is a biased estimate of future interest rate levels. Nevertheless, we find some evidence that the behaviour of market participants, when making predictions about the future level of interest rates, is not entirely in line with what rational behaviour would suggest. We also find that there is strong evidence of time-variation in the term structure of interest rates. Furthermore, while this variation in term premia can be very well explained by low-order variations of the ARMA class models, there is sufficient evidence that the conditional heteroskedasticity of term premia plays an important role in explaining the time-variation. Finally, no significant difference is found between the behaviour of EMS interest rate deposits and non-EMS deposits.

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Bibliographic Reference

Jongen, R, Verschoor, W and Wolff, C. 2005. 'Time Variation in Term Premia: International Evidence'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=4959