THE EXPECTATIONS HYPOTHESIS OF THE TERM STRUCTURE IN EUROCURRENCY MARKETS

This paper uses daily eurocurrency deposit rates for six currencies to extend previous research on the expectations hypothesis of the term structure. The reported results confirm earlier findings that the behavior of long term interest rates is perverse. For example, it is shown that in the case of five-year eurocurrency deposits denominated in US dollars, German marks and Swiss francs, the coefficient relating the excess holding period return to the yield spread between long and short term securities exceeds one, implying that long term rates tend to move in a direction opposite to the prediction of the expectations hypothesis. This study also employs a variety of techniques to examine the temporal stability of the coefficient in both the long and short maturity regressions used in testing the expectations hypothesis. While we do find instability, the nature of the parameter variation is markedly different from that found in foreign exchange markets when similar tests are employed.