Expectations Hypotheses Tests

Geert Bekaert, Robert J. Hodrick

NBER Working Paper No. 7609
Issued in March 2000
NBER Program(s):   AP

We investigate the Expectations Hypotheses of the term structure of interest rates and of the foreign exchange market using vector autoregressive methods for the U.S. dollar, Deutsche mark, and British pound interest rates and exchange rates. In addition to standard Wald tests, we formulate Lagrange Multiplier and Distance Metric tests which require estimation under the non-linear constraints of the null hypotheses. Estimation under the null is achieved by iterating on approximate solutions that require only matrix inversions. We use a bias-corrected, constrained vector autoregression as a data generating process and construct extensive Monte Carlo simulations of the various test statistics under the null hypotheses. Wald tests suffer from severe size distortions and use of the asymptotic critical values results in gross over-rejection of the null. The Lagrange Multiplier tests slightly under-reject the null, and the Distance Metric tests over-reject. Use of the small sample distributions of the different tests leads to a common interpretation of the validity of the Expectations Hypotheses. The evidence against the Expectations Hypotheses for these interest rates and exchange rates is much less strong than under asymptotic inference.

download in pdf format
   (444 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w7609

Published: Bekaert, Geert and Robert J. Hodrick. "Expectations Hypotheses Tests," Journal of Finance, 2001, v56(4,Aug), 1357-1394. citation courtesy of

Users who downloaded this paper also downloaded* these:
Froot w2363 New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates
Campbell and Shiller w3153 Yield Spreads and Interest Rate Movements: A Bird's Eye View
Bekaert, Hodrick, and Marshall t0191 On Biases in Tests of the Expecations Hypothesis of the Term Structure Of Interest Rates
Sangvinatsos and Wachter w10086 Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors
Bekaert, Wei, and Xing w8795 Uncovered Interest Rate Parity and the Term Structure
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us