This paper tests the rational expectations hypothesis (REH) for Brazil
from July 1996 to December 2001. For any pair of maturities between one day
and one year, it shows that the yield spread between a longer-term and a
shorterterm interest rate is an imprecise predictor of the short-term
movements in the longer-term interest rate and of the long-term movements in
the shorter-term interest rate. Moreover, yield spreads highly correlated
with the rational expectations forecasts of future changes in the
shorter-term rate, but significantly more volatile than these, suggest the
rejection of the REB. The alternative hypothesis of overreaction of the
yield spread to the expectation of future changes in the shorter-term rate
seems a reasonable explanation to these findings, and can be rationalized by
a monetary policy of interest rate smoothing.
Insolvency or Liquidity Squeeze? Explaining Very Short-Term Corporate Yield Spreads