A Defense of Traditional Hypotheses about the Term Structure of Interest Rates



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    • Department of Economics, Princeton University. This paper is based on Chapter 2 of my Yale Ph.D. Dissertation, Asset Duration and Time-Varying Risk Premia. I am grateful to Ed Kane, Pete Kyle, Huston McCulloch, Kermit Schoenholtz, Robert Shiller, and an anonymous referee for helpful correspondence and discussions, and particularly to Pete Kyle for showing me how to fill an important gap in the argument. I am responsible for any remaining errors.


Expectations theories of asset returns may be interpreted either as stating that risk premia are zero or that they are constant through time. Under the former interpretation, different versions of the expectations theory of the term structure are inconsistent with one another, but I show that this does not necessarily carry over to the constant risk premium interpretation of the theory. I present a general equilibrium example in which different types of risk premium are constant through time and dependent only on maturity. Furthermore, I argue that differences among expectations theories are second-order effects of bond yield variability. I develop an approximate linearized framework for analysis of the term structure in which these differences disappear, and I test its accuracy in practice using data from the CRSP government bond tapes.