Time-varying term premia and the expectations hypothesis in Australia

Abstract

This article investigates whether the (rational) expectations hypothesis holds for Australian yield data (it does not), whether the hypothesis holds after adjusting for term premia estimated from an affine term structure model (it appears to) and whether the yield process implied by the term structure model can match the failure of the hypothesis on unadjusted yields (it can). These results suggest that the term structure model used in Finlay and Chambers (2009) does a reasonable job in capturing the risk-neutral and real-world dynamics of Australian interest rates, at least as measured through the prism of the expectations hypothesis.