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Testing the expectations hypothesis of the term structure using instrumental variables
Author(s) -
Driffill John,
Psaradakis Zacharias,
Sola Martin
Publication year - 1998
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/(sici)1099-1158(199810)3:4<321::aid-ijfe82>3.0.co;2-c
Subject(s) - econometrics , economics , instrumental variable , term (time) , contrast (vision) , yield curve , monte carlo method , yield (engineering) , statistics , statistical hypothesis testing , mathematics , interest rate , computer science , macroeconomics , physics , quantum mechanics , materials science , artificial intelligence , metallurgy
This paper demonstrates, by means of Monte Carlo experimentation, that tests of the expectations hypothesis of the term structure based on instrumental variables regressions of the change in the short rate on the relevant lagged yield spread are prone to severe over‐rejection when the term premium is time‐varying. In contrast, tests based on regressions of the yield spread on the first‐difference of the short rate are found to reject at the correct rate in moderately sized samples. © 1998 John Wiley & Sons, Ltd.