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Direct tests of the expectations theory of the term structure: Survey expectations, the term premium and coefficient biases

Smant, David / D.J.C. (2010): Direct tests of the expectations theory of the term structure: Survey expectations, the term premium and coefficient biases.

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Abstract

A common perception in the literature seems to be that the expectations theory of the term structure of interest rates (ET) is rejected by the empirical tests. However, the overall evidence across countries and time periods is actually mixed between frequent support and occasional rejection of the ET and requires careful interpretation. This paper builds on two premises. First, the general version of the expectations theory does not require a constant term premium. Second, contrary to the classic perfect-foresight-with-error hypothesis real world rational expectations do not necessarily satisfy unbiasedness and ex post efficiency conditions. Direct tests that take into account the weaknesses of the restrictive auxiliary assumptions show that the expectations theory fits the term structure data very well.

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