NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

On Biases in Tests of the Expecations Hypothesis of the Term Structure Of Interest Rates

Geert Bekaert, Robert J. Hodrick, David A. Marshall

NBER Technical Working Paper No. 191
Issued in January 1996
NBER Program(s):   AP

We document extreme bias and dispersion in the small sample distributions of five standard regression tests of the expectations hypothesis of the term structure of interest rates. These biases derive from the extreme persistence in short interest rates. We derive approximate analytic expressions for these biases, and we characterize the small-sample distributions of these test statistics under a simple first-order autoregressive data generating process for the short rate. The biases are also present when the short rate is modeled with a more realistic regime-switching process. The differences between the small-sample distributions of test statistics and the asymptotic distributions partially reconcile the different inferences drawn when alternative tests are used to evaluate the expectations hypothesis. In general, the test statistics reject the expectations hypothesis more strongly and uniformly when they are evaluated using the small-sample distributions, as compared to the asymptotic distributions.

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Document Object Identifier (DOI): 10.3386/t0191

Published: Journal of Financial Economics, Vol.44 (June 1997): 309-348.

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