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Expectations Hypothesis

  1. Antonios Sangvinatsos

Published Online: 15 MAY 2010

DOI: 10.1002/9780470061602.eqf03005

Encyclopedia of Quantitative Finance

Encyclopedia of Quantitative Finance

How to Cite

Sangvinatsos, A. 2010. Expectations Hypothesis. Encyclopedia of Quantitative Finance. .

Author Information

  1. University of Southern California, Los Angeles, CA, USA

Publication History

  1. Published Online: 15 MAY 2010

Abstract

The term expectations hypothesis (EH) stands for numerous statements that link the behavior of short-term and long-term interest rates. The literature distinguishes between the pure expectations hypothesis (PEH), which postulates that (i) expected excess returns on long-term over short-term bonds are zero, (ii) yield term premia are zero, or (iii) forward term premia are zero, from the EH, which postulates that (i) expected excess returns are constant over time, (ii) yield term premia are constant, or (iii) forward term premia are constant over time. We present all the forms of the PEH in discrete time with discrete and continuous compounding and in continuous time (continuous compounding). We will see that the PEH expressions derived in all these models are not equivalent across models as well as within each model.

Keywords:

  • expectations hypothesis;
  • forwards;
  • returns;
  • bonds;
  • yields;
  • term structure