| Abstract: | This paper applies the Kalman filter technique to look at the relationship among real interest rates, inflation, and the term structure of interest rate under the expectations hypothesis. Using quarterly data from 1960:1 to 1991:1 for inflation, three month nominal short term interest rates and long term yields with maturities from one to five years, this paper finds that the expectations hypothesis of the term structure holds up well for the data under the assumptions of a time-varying premium and a random-walk real interest rate. In other words, a reconciliation of the expectations hypothesis with the data is attained by assuming time-varying term premium and non-stationary real interest rate. |
