Conventional Valuation and the Term Structure of Interest Rates
NBER Working Paper No. 1610
There does not appear to be a general tendency for long-term interest rates either to overreact or to underreact to short-term interest rates relative to a rational expectations model of the term structure. Rather, there appears to be some tendency for markets to set long-term interest rates in terms of a convention or rule of thumb that makes long rates behave as a distributed lag, with gradually declining coefficients, of short-term interest rates. People seem to remember the recent past but blur the mare distant. In some monetary policy regimes this convention implies overreaction, in others underreaction.
Document Object Identifier (DOI): 10.3386/w1610
Published: Rudiger Dornbusch et. al. eds., Macroeconomics and Finance: Essays in Honor of Franco Modigliani, Cambridge, MIT Press, 1987