TIME VARYING RISK PREMIUM AND THE PREDICTIVE POWER OF THE AUSTRALIAN TERM STRUCTURE OF INTEREST RATES

Using weekly data on bank accepted bills over the 1976 to 1993 period, this paper provides direct evidence of the presence of a term premium in the Australian term structure. The term premium is shown to vary over time and have an adverse effect on the predictive power of the term structure. The variance of the expected term premium is quantified in terms of its lower bound relative to the upper bound of the variance of the rational expectations error. This ratio is observed to vary over sample sub periods and rise to a high of one in some periods which include the period immediately prior to the market crash.     

A VARIANCE DECOMPOSITION ANALYSIS OF THE INFORMATION IN THE TERM STRUCTURE

Based on a market efficiency assumption, we use variance decomposition analysis to separate information in the term structure on expected future spot rates from information on time-varying term premia and to examine the market's ability to forecast both future rate changes and excess returns on long versus short securities. We find that fluctuations in the slope of the yield curve are due more to changing term premia than to fluctuations in expected future spot rates and that the market correctly predicts about 40 percent of the month-to-month changes in spot rates, a considerably higher percentage than that found by previous studies.     

THE TERM PREMIA RELATIONSHIP IMPLICIT IN THE TERM STRUCTURE OF TREASURY BILLS

This paper considers a single coefficient representation of the term premia relationship that appears in treasury bill yield curves. Term premia are defined as positive or negative maturity-dependent differentials versus the instantaneous nominal spot rate. The term premia function is developed in the context of the Cox, Ingersoll, and Ross [ 3 ] Risk-Averse Preferred Habitat Model and proxies for the degree of risk aversion exhibited by the universe of treasury bill investors at a point in time. Empirical results indicate that term premia are influenced by a set of macroeconomic variables in the expected manner.     

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.     

TESTING THE PREDICTIVE POWER OF EX-POST EFFICIENT PORTFOLIOS

Tested here is the hypothesis that portfolios selected from among ex-post efficient assets will attain better results ex-ante than by following the naive strategy of holding an equally weighted portfolio of all the assets. The tests are conducted using the returns of the one hundred mutual funds that were continuously in operation from 1959 to 1980. Ex-post efficient funds are identified using nine investment decision rules (Stochastic Dominance and Mean-Variance rules with and without riskless asset and the Geometric Mean rule). Ex-ante performance is assessed in terms of terminal wealth and expected utility. Results indicate that over the twenty-two years tested, significantly better performance could be attained ex-ante by investing in mutual funds selected by ex-post efficiency analysis using the distribution-free Second- and Third-Degree Stochastic Dominance tests with Riskless Asset as well as by the more traditional Mean-Variance test with Riskless Asset. Excess returns from using ex-post information exceed the substantial transaction costs incorporated in the analysis.     

THE SLOPE OF THE TERM STRUCTURE OF CREDIT SPREADS: AN EMPIRICAL INVESTIGATION

In this article we analyze the slope of the term structure of credit spreads. We investigate the explanatory role of interest rate, market, and idiosyncratic equity variables that the recent empirical literature highlights as important determinants of credit spread levels. This study extends the analysis and assesses its effect on credit slopes for a sample of corporate bonds. We find that these factors affect credit spreads at short and long maturities in a significantly different way. A closer inspection of the credit spread slope also reveals that it is a useful indicator of the direction of changes in future short‐term credit spreads. This evidence has important implications for the trading and risk management of portfolios of bonds with different maturities.     

AN EMPIRICAL STUDY OF A NEW CLASS OF NO-ARBITRAGE-BASED DISCRETE MODELS OF THE TERM STRUCTURE

We present empirical tests of the new no-arbitrage-based term structure paradigm in discrete time. We derive and test empirical specifications for deterministic one-factor forward rate volatility models and examine the compatibility of these forward rate volatility functions using term structure dynamics. Our estimation technique uses the generalized method of moments and is based on forward bond price deviations. We do not impose restrictions on the market price of risk, and we incorporate all available term structure information. Our data consist of four sets of pure discount bonds derived from the CRSP bond files and U.S. Treasury bill quotes.     

THE TERM STRUCTURE OF INTEREST RATES AS A COINTEGRATED SYSTEM: EMPIRICAL EVIDENCE FROM THE EUROCURRENCY MARKET

In this paper I examine the term structure of Eurocurrency interest rates from six countries (with maturities of one, two, three, and six months) using unit root tests and cointegration tests that are robust to departures from independent and identically distributed errors. The main conclusions are: (1) Eurocurrency interest rates have one (and only one) unit root when viewed individually, and (2) for each of the countries examined, Eurocurrency interest rates are cointegrated—with one equilibrium relationship—when viewed jointly. These conclusions are consistent with the weak form of the efficient market hypothesis and suggest that in efficient markets arbitrage generally prevents rates on different maturities of a given asset from drifting too far for an extended period.