The Expectations Hypothesis of the Term Structure and Time Varying Risk Premia: A Panel Data Approach

The shape of the Chicago Board Options Exchange Volatility Index (VIX) term structure conveys information about the price of variance risk rather than expected changes in the VIX, a rejection of the expectations hypothesis. The second principal component, SLOPE, summarizes nearly all this information, predicting the excess returns of synthetic Standard & Poor’s (S&P) 500 variance swaps, VIX futures, and S&P 500 straddles for all maturities and to the exclusion of the rest of the term structure. SLOPE’s predictability is incremental to other proxies for the conditional variance risk premia, economically significant, and inconsistent with standard asset pricing models.

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Term spread regressions of the rational expectations hypothesis of the term structure allowing for risk premium effects

Studies in Nonlinear Dynamics & Econometrics ◽

10.1515/snde-2012-0024 ◽

2015 ◽

Vol 19 (1) ◽

Cited By ~ 5

Author(s):

Efthymios Argyropoulos ◽

Elias Tzavalis

Keyword(s):

Interest Rates ◽

Term Structure ◽

Rational Expectations ◽

Time Varying ◽

Structure Model ◽

Expectations Hypothesis ◽

Term Structure Model ◽

Term Spread ◽

Term Premium

AbstractThis paper suggests a new empirical methodology of testing the predictions of the term spread between long and short-term interest rates about future changes of the former allowing for term premium effects, according to the rational expectations hypothesis of the term structure. To capture the effects of a time-varying term premium on the term spread, the paper relies on an empirically attractive affine Gaussian dynamic term structure model which assumes that the term structure of interest rates is spanned by three unobserved state variables. To retrieve accurate values of these variables from interest rates series, the paper suggests a new method which can overcome the effects of measurement (or pricing) errors inherent in these series on the estimates of the model. This method is assessed by a Monte Carlo study. Ignoring these errors will lead to biased estimates of term structure models. The empirical results of the paper provide support for the suggested term structure model. They show that this model can efficiently capture the time-varying term premium effects embodied in long-term interest rates, which can explain the failures of term spread to forecast future changes in long-term rates.

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Disappointment Aversion, Term Structure, and Predictability Puzzles in Bond Markets

Management Science ◽

10.1287/mnsc.2020.3757 ◽

2020 ◽

Author(s):

Patrick Augustin ◽

Roméo Tédongap

Keyword(s):

Interest Rates ◽

Term Structure ◽

Dynamic Equilibrium ◽

Time Varying ◽

State Variables ◽

Expectations Hypothesis ◽

Macroeconomic Uncertainty ◽

Disappointment Aversion ◽

Nominal Interest Rates ◽

Continuous State

We solve a dynamic equilibrium model with generalized disappointment-aversion preferences and continuous state-endowment dynamics. We apply the framework to the term structure of interest rates and show that the model generates an upward-sloping term structure of nominal interest rates and a downward-sloping term structure of real interest rates and that it accounts for the failure of the expectations hypothesis. The key ingredients are preferences with disappointment aversion, preference for early resolution of uncertainty, and an endowment economy with three state variables: time-varying macroeconomic uncertainty, time-varying expected inflation, and inflation uncertainty. This paper was accepted by Karl Diether, finance.

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