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The small sample properties of tests of the expectations hypothesis: a Monte Carlo investigation

✍ Scribed by Eugenie Garganas; Stephen G. Hall

Publisher: John Wiley and Sons
Year: 2011
Tongue: English
Weight: 372 KB
Volume: 16
Category: Article
ISSN: 1076-9307
DOI: 10.1002/ijfe.422

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✦ Synopsis

In this paper, we extend results from the finance literature that explores small sample bias, due to persistent variables, in tests of present value asset pricing models. Using a Monte Carlo simulation approach, we investigate the finite sample behaviour of standard tests of the expectations hypothesis (EH) of the term structure, when interest rates are increasingly persistent. We document bias for the 'perfect foresight spread' regression and find that the variance bound statistic strongly tends to favour the EH when persistence is high. In a vector autoregression (VAR) framework, the Wald test and the slope of the ordinary least squares test using the 'VAR-theoretical spread' are strongly biased.

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