The Expectation Hypothesis of the Term Structure of Very Short-Term Rates: Statistical Tests and Economic Value

Lucio Sarno, Daniel Thornton and Pasquale Della Corte

No 6445, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper re-examines the validity of the Expectation Hypothesis (EH) of the term structure of US repo rates ranging in maturity from overnight to three months. We extend the work of Longstaff (2000a) in two directions: (i) we implement statistical tests designed to increase test power in this context; (ii) more importantly, we assess the economic value of departures from the EH based on criteria of profitability and economic significance in the context of a simple trading strategy. The EH is rejected throughout the term structure examined on the basis of the statistical tests. However, the results of our economic analysis are favorable to the EH, suggesting that the statistical rejections of the EH in the repo market are economically insignificant.

Keywords: Economic value; Expectation hypothesis; Term structure of interest rates; Vector autoregression (search for similar items in EconPapers)
JEL-codes: E43 G10 (search for similar items in EconPapers)
Date: 2007-09
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (13)

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Related works:
Journal Article: The expectation hypothesis of the term structure of very short-term rates: Statistical tests and economic value (2008)
Working Paper: The expectation hypothesis of the term structure of very short-term rates: statistical tests and economic value (2007)
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