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The Empirical Failure of the Expectations Hypothesis of the Term Structure of Bond Yields

Published online by Cambridge University Press:  06 April 2009

Lucio Sarno ,
Daniel L. Thornton  and
Giorgio Valente
Lucio Sarno
Affiliation:
lucio.sarno@warwick.ac.uk, Finance Group, Warwick Business School, University of Warwick, Coventry, CV4 7AL, UK
Daniel L. Thornton
Affiliation:
thornton@stls.frb.org, Federal Reserve Bank of St. Louis, PO Box 442, St. Louis, MO 63166
Giorgio Valente
Affiliation:
giorgio.valente@cuhk.edu.hk, Department of Finance, The Chinese University of Hong Kong, Shatin, N.T., Hong Kong
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Abstract

This paper tests the expectations hypothesis (EH) using U.S. monthly data for bond yields spanning the 1952–2003 sample period and ranging in maturity from one month to 10 years. We apply the Lagrange multiplier test developed by Bekaert and Hodrick (2001) and extend it to increase the test power by introducing economic variables as conditioning information and by using more than two bond yields in the model and testing the EH jointly on more than one pair of yields. While the conventional bivariate procedure provides mixed results, the more powerful testing procedures suggest rejection of the EH throughout the maturity spectrum examined.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 42 , Issue 1 , March 2007 , pp. 81 - 100
Copyright
Copyright © School of Business Administration, University of Washington 2007

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